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Sharing of longevity basis risk in pension schemes with income-drawdown guarantees

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  • Ankush Agarwal
  • Christian-Oliver Ewald
  • Yongjie Wang

Abstract

This work studies a stochastic control problem for a pension scheme which provides an income-drawdown policy. The manager and members agree to share the investment risk based on a risk-sharing rule. The objective is to maximise both sides’ utilities by controlling the investment strategy and benefit withdrawals. We use stochastic affine class models to describe the force of mortality and consider a longevity bond whose coupon payment is linked to a survival index. We also investigate the longevity basis risk, which arises when the members’ and the longevity bond’s reference populations correlate imperfectly. By applying the dynamic programming principle to solve the corresponding HJB equations, we derive optimal solutions for the single and sub-population cases. Our numerical results show that both manager and members benefit from sharing the risk. Moreover, even in the presence of longevity basis risk, we demonstrate that the longevity bond acts as an effective hedging instrument.

Suggested Citation

  • Ankush Agarwal & Christian-Oliver Ewald & Yongjie Wang, 2020. "Sharing of longevity basis risk in pension schemes with income-drawdown guarantees," Working Papers 2020_18, Business School - Economics, University of Glasgow.
    • Handle: RePEc:gla:glaewp:2020_18
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    References listed on IDEAS

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    Cited by:

    1. Ankush Agarwal & Christian-Oliver Ewald & Yongjie Wang, 2023. "Hedging longevity risk in defined contribution pension schemes," Computational Management Science, Springer, vol. 20(1), pages 1-34, December.

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    More about this item

    Keywords

    Pension scheme; longevity basis risk; mortality-linked instrument; stochastic control; dynamic programming principle;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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