2006-10-18Buch DOI: 10.18452/8361
Optimal Hedging Strategies for Multi-periodGuarantees in the Presence of Transaction Costs:A Stochastic Programming Approach
Multi-period guarantees are often embedded in life insurance contracts. In this paper we consider the problem of hedging these multi-period guarantees in the presence of transaction costs. We derive thehedging strategies for the cheapest hedge portfolio for a multi-periodguarantee that with certainty makes the insurance company able tomeet the obligations from the insurance policies it has issued. We findthat by imposing transaction costs, the insurance company reducesthe rebalancing of the hedge portfolio. The cost of establishing thehedge portfolio also increases as the transaction cost increases. Forthe multi-period guarantee there is a rather large rebalancing of thehedge portfolio as we go from one period to the next. By introducingtransaction costs we find the size of this rebalancing to be reduced.Transaction costs may therefore be one possible explanation for whywe do not see the insurance companies performing a large rebalancingof their investment portfolio at the end of each year.
Is Part Of Series: European J. of Operational Research, 3, 185, 2008