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Economic Pricing of Mortality-linked Securities in the Presence of Population Basis Risk

Author

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  • Rui Zhou

    (Statistics and Actuarial Science, University of Waterloo, 200 University Ave. W., Waterloo, Ontario, N2L3G1, Canada)

  • Johnny Siu-Hang Li

    (Statistics and Actuarial Science, University of Waterloo, 200 University Ave. W., Waterloo, Ontario, N2L3G1, Canada)

  • Ken Seng Tan

    (Statistics and Actuarial Science, University of Waterloo, 200 University Ave. W., Waterloo, Ontario, N2L3G1, Canada)

Abstract

Standardised mortality-linked securities are easier to analyse and more conducive to the development of liquidity. However, when a pension plan relies on standardised instruments to hedge its longevity risk exposure, it is inevitably subject to various forms of basis risk. In this paper, we use an economic pricing method to study the impact of population basis risk, that is, the risk due to the mismatch in the populations of the exposure and the hedge, on prices of mortality-linked securities. The pricing method we consider is highly transparent, allowing us to understand how population basis risk affects the demand and supply of a mortality-linked security. We apply the method to a hypothetical longevity bond, using real mortality data from different populations. Our illustrations show that, interestingly, population basis risk can affect the price of a mortality-linked security in different directions, depending on the properties of the populations involved.

Suggested Citation

  • Rui Zhou & Johnny Siu-Hang Li & Ken Seng Tan, 2011. "Economic Pricing of Mortality-linked Securities in the Presence of Population Basis Risk," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 36(4), pages 544-566, October.
    • Handle: RePEc:pal:gpprii:v:36:y:2011:i:4:p:544-566
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    Citations

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    Cited by:

    1. Rui Zhou & Johnny Siu-Hang Li & Ken Seng Tan, 2013. "Pricing Standardized Mortality Securitizations: A Two-Population Model With Transitory Jump Effects," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 80(3), pages 733-774, September.
    2. Blake, David & Cairns, Andrew J.G., 2021. "Longevity risk and capital markets: The 2019-20 update," Insurance: Mathematics and Economics, Elsevier, vol. 99(C), pages 395-439.
    3. Blake, David & El Karoui, Nicole & Loisel, Stéphane & MacMinn, Richard, 2018. "Longevity risk and capital markets: The 2015–16 update," Insurance: Mathematics and Economics, Elsevier, vol. 78(C), pages 157-173.
    4. Tan, Chong It & Li, Jackie & Li, Johnny Siu-Hang & Balasooriya, Uditha, 2014. "Parametric mortality indexes: From index construction to hedging strategies," Insurance: Mathematics and Economics, Elsevier, vol. 59(C), pages 285-299.
    5. Liu, Yanxin & Li, Johnny Siu-Hang, 2015. "The age pattern of transitory mortality jumps and its impact on the pricing of catastrophic mortality bonds," Insurance: Mathematics and Economics, Elsevier, vol. 64(C), pages 135-150.
    6. Li, Johnny Siu-Hang & Zhou, Rui & Hardy, Mary, 2015. "A step-by-step guide to building two-population stochastic mortality models," Insurance: Mathematics and Economics, Elsevier, vol. 63(C), pages 121-134.
    7. Zhou, Rui & Li, Johnny Siu-Hang & Tan, Ken Seng, 2015. "Modeling longevity risk transfers as Nash bargaining problems: Methodology and insights," Economic Modelling, Elsevier, vol. 51(C), pages 460-472.

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