Longevity hedge effectiveness using socioeconomic indices

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Abstract

This paper evaluates socioeconomic basis risk in longevity hedging. Using data for a full population stratified into socioeconomic groups, we explore the benefits and costs of two alternative hedging strategies, with and without basis risk, in the capital market. The benefit of the longevity hedge is represented by the risk reduction in the variability of a life annuity, whereas the cost is the notional amount of hedging contracts times the actuarial risk premium. We find that hedging is more cost-effective for the annuity provider when basis risk is eliminated. Moreover, it allows for a higher degree of hedge effectiveness at a cost that is equivalent to a hedge where basis risk is present. Finally, the yearly expenses related to hedging longevity risk require, at most, an extra added rate of return of no more than 0.16%.

Original languageEnglish
JournalInsurance: Mathematics and Economics
Volume114
Pages (from-to)242 - 251
Number of pages10
ISSN0167-6687
DOIs
Publication statusPublished - Jan 2024

Keywords

  • Basis risk
  • Hedge effectiveness
  • Longevity risk
  • Q-forwards
  • Socioeconomic groups
  • Static hedging

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