Pricing Pension Buy-outs under Stochastic Interest and Mortality Rates

Ayse Arik*, Yeliz Yolcu-Okur, Şule Şahin, Ömür Uğur

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

Pension buy-out is a special financial asset issued to offload the pension liabilities holistically in exchange for an upfront premium. In this paper, we concentrate on the pricing of pension buy-outs under dependence between interest and mortality rates risks with an explicit correlation structure in a continuous time framework. Change of measure technique is invoked to simplify the valuation. We also present how to obtain the buy-out price for a hypothetical benefit pension scheme using stochastic models to govern the dynamics of interest and mortality rates. Besides employing a non-mean reverting specification of the Ornstein–Uhlenbeck process and a continuous version of Lee–Carter setting for modeling mortality rates, we prefer Vasicek and Cox–Ingersoll–Ross models for short rates. We provide numerical results under various scenarios along with the confidence intervals using Monte Carlo simulations.
Original languageEnglish
Pages (from-to)173-190
Number of pages18
JournalScandinavian Actuarial Journal
Volume2018
Issue number3
DOIs
Publication statusPublished - 16 Mar 2018

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