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Assessing basis risk in index-based longevity swap transactions

Author

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  • Li, Jackie
  • Li, Johnny Siu-Hang
  • Tan, Chong It
  • Tickle, Leonie

Abstract

In this paper, we carry out an investigation on modelling basis risk and measuring risk reduction in a longevity hedge constructed by index-based longevity swaps. We derive the fitting procedures of the M7-M5 and common age effect+Cohorts models and define the level of longevity risk reduction. Based on a wide range of hedging scenarios of pension plans, we find that the risk reduction levels are often around 50%–80% for a large plan, while the risk reduction estimates are usually smaller than 50% for a small plan. Moreover, index-based hedging looks more effective under a more precise hedging scheme. We also perform a detailed sensitivity analysis on the hedging results. The most important modelling features are the behaviour of simulated future variability, portfolio size, speed of reaching coherence, data size and characteristics, simulation method, and mortality structural changes.

Suggested Citation

  • Li, Jackie & Li, Johnny Siu-Hang & Tan, Chong It & Tickle, Leonie, 2019. "Assessing basis risk in index-based longevity swap transactions," Annals of Actuarial Science, Cambridge University Press, vol. 13(1), pages 166-197, March.
    • Handle: RePEc:cup:anacsi:v:13:y:2019:i:01:p:166-197_00
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    Cited by:

    1. Kallestrup-Lamb, Malene & Søgaard Laursen, Nicolai, 2024. "Longevity hedge effectiveness using socioeconomic indices," Insurance: Mathematics and Economics, Elsevier, vol. 114(C), pages 242-251.
    2. Kenneth Q. Zhou & Johnny S.-H. Li & Pintao Lyu, 2024. "Bringing parametric mortality indexes to practice: a generalized CBD model with stochastic socioeconomic differentials in mortality improvements," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 49(2), pages 295-319, April.
    3. de Jong, Piet & Tickle, Leonie & Xu, Jianhui, 2020. "A more meaningful parameterization of the Lee–Carter model," Insurance: Mathematics and Economics, Elsevier, vol. 94(C), pages 1-8.
    4. Tan, Ken Seng & Weng, Chengguo & Zhang, Jinggong, 2022. "Optimal dynamic longevity hedge with basis risk," European Journal of Operational Research, Elsevier, vol. 297(1), pages 325-337.

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