Actuaries and Derivatives

Abstract

This paper draws analogies between techniques used to reserve for, control and manage derivatives and techniques used by actuaries in other fields. It concentrates on equity derivatives. It also includes a review of the factors which significantly influence the appropriate size of reserves to hold for a derivatives portfolio. These include the likelihood of market jumps, uncertainty in future market volatility and the size of transaction costs, as well as on more obvious factors like position risk.

The application of financial theory to the pricing of upward-only rent reviews

“…A more useful treatment would recognize that volatility might also depend on the underlying asset value, S. If this is the case, the Black-Scholes formula cannot generally be used, even in a revised form (see Section 8.1 of Kemp, 1997). A more useful treatment would recognize that volatility might also depend on the underlying asset value, S. If this is the case, the Black-Scholes formula cannot generally be used, even in a revised form (see Section 8.1 of Kemp, 1997).…”

British Actuarial Journal celebrates its 20th anniversary

“…More disruptive than stochastic modelling was the impact of option pricing theory on actuarial work. Kemp (1997) introduced equity and interest rate derivatives, whereas Muir et al (2007) described the credit derivatives market. Huber & Verrall (1999) advocated a more theoretically based approach to actuarial economic models in preference to the empirical data-based time series approach of Wilkie (1995), Varnell (2011) gives further details of what this means in practice.…”

Risk Management in a Fair Valuation World

“…Perhaps its existence, or nonexistence, is less important than conventional wisdom might imply is the case; autocorrelation does not necessarily have to be inconsistent with efficient markets, if you posit a time varying 'price of risk'. 7.4 An Apparent Aside: Mileage Options 7.4.1 In my opinion, one of the most powerful conceptual tools relevant to understanding option pricing theory is a hypothetical (total return) option called a mileage option, explored by Neuberger (1990), and referred to in Kemp (1997). An analysis of it succinctly encapsulates essentially all of the ways in which the fair value of a derivative instrument can diverge from the celebrated Black-Scholes option pricing formulae and their extensions.…”