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The Pricing Model of Pension Benefit Guaranty Corporation Insurance with Regime-Switching Processes

Author

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  • Ting-Fu Chen

    (Department of Applied Mathematics, Feng Chia University, Taichung 407, Taiwan)

  • Shih-Kuei Lin

    (Department of Money and Banking, National Chengchi University, Taipei City 116, Taiwan)

  • An-Sing Chang

    (Department of Money and Banking, National Chengchi University, Taipei City 116, Taiwan)

  • Wei-Hao Wang

    (Cathay Life Insurance, Taipei City 106, Taiwan)

Abstract

This paper aims to evaluate Pension Benefit Guaranty Corporation (PBGC) insurance values through regime-switching models. We separate periods of the economy with faster growth from those with slower growth to observe long-term trends in the economy. We derive a fair PBGC insurance pricing formula under distress termination and intervention termination using regime-switching processes. We set parameters by estimating the S&P 500 index and one-year treasury bills via expectation maximization particle swarm optimization (EM-PSO)-Gradient, which is an extension of the EM-Gradient method. Then, we conduct sensitivity analysis to investigate the impact of model parameters on insurance values. According to the maximum likelihood estimation results, the Akaike information criterion (AIC) and Bayesian information criterion (BIC) estimators show that the regime-switching process has better goodness of fit than the geometric Brownian motion. Scenario analysis also supports the adequacy of our pricing formula.

Suggested Citation

  • Ting-Fu Chen & Shih-Kuei Lin & An-Sing Chang & Wei-Hao Wang, 2022. "The Pricing Model of Pension Benefit Guaranty Corporation Insurance with Regime-Switching Processes," JRFM, MDPI, vol. 15(6), pages 1-23, June.
    • Handle: RePEc:gam:jjrfmx:v:15:y:2022:i:6:p:258-:d:834988
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    References listed on IDEAS

    as
    1. Giorgio Costa & Roy H. Kwon, 2019. "Risk parity portfolio optimization under a Markov regime-switching framework," Quantitative Finance, Taylor & Francis Journals, vol. 19(3), pages 453-471, March.
    2. Alan Marcus, 1987. "Corporate Pension Policy and the Value of PBGC Insurance," NBER Chapters, in: Issues in Pension Economics, pages 49-80, National Bureau of Economic Research, Inc.
    3. Christopher M. Lewis & George Pennacchi, 1994. "The value of Pension Benefit Guaranty Corporation insurance," Proceedings, Federal Reserve Bank of Cleveland, pages 735-756.
    4. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
    5. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    6. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-186, March.
    Full references (including those not matched with items on IDEAS)

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