The Cost of Counterparty Risk and Collateralization in Longevity Swaps

Abstract

This is the accepted version of the paper.This version of the publication may differ from the final published version. We examine the impact of bilateral default risk and collateral rules on the marking to market of longevity swaps, and show how longevity swap rates must be determined endogenously from the collateral flows associated with the marking-to-market procedure. Permanent repository linkFor typical interest rate and mortality parameters, we find that the impact of collateralization is modest in the presence of symmetric default risk, but more pronounced when default risk and/or collateral rules are asymmetric. Our results suggest that the overall cost of collateralization is comparable with, and often much smaller than, that found in the interest-rate swaps market, which may then provide the appropriate reference framework for the credit enhancement of both indemnity-based and indexed longevity risk solutions.

Maximum Market Price of Longevity Risk Under Solvency Regimes: The Case Of Solvency II

“…We can see a distinctive cohort effect in the parameter γ (3) c , showing that cohort mortality is rising at a higher rate for males born after 1920. In the estimation of the cohort effect, we excluded cohorts for which there were less than 5 observations: cohorts birth in 1884-1887 and 1944-1947.…”

“…Balancing between the best selected ARIMA models fitting the parameters 2 and the desire to deal with a simple model, we chose an ARIMA(0,1,0) to describe the first two parameters, k (1) and k (2) , and an ARIMA (1,1,0) for the cohort parameter γ (3) c . We assume the existence of correlation between parameter k (1) t and k (2) t , while we 2 The goodness of fit is assessed through both the maximum log-likelihood function and the Akaike's Information Criterion AIC = 2l + 2K where l is the log likelihood function and K the effective number of estimated parameters.…”

“…However, longevity-linked securities are affected by the counterparty default risk that can increase their costs and implies a specific capital charge for the insurer entering in the transaction (see Biffis et al [3] for an analysis of counterparty default risk in longevity swaps). The calculation of the risk margin for counterparty default risk in longevity-linked securities is beyond the scope of this paper.…”

Robust Mean–Variance Hedging of Longevity Risk

“…As compared to traditional approaches such as reinsurance, mortality-linked derivatives may provide cheaper and more flexible options of mitigating longevity risk exposure (Cairns et al, 2014). 1 Our article contributes to the rapidly growing literature on longevity risk management (see, e.g., Biffis et al, 2014;Wong, Chiu, and Wong, 2015) by explicitly taking estimation inaccuracy and model risk into account in the optimization problem. Empirical studies show that the solutions to portfolio optimization problems can be rather sensitive to small errors in the assumed underlying probability distribution (Garlappi, Uppal, and Wang, 2007).…”

Yes We Can (Price Derivatives on Survivor Indices)

“…Although not all longevity risk transfers are reported in that survey, one does have the impression that the market is not picking up steam as much as what was first believed in the early years of the 21st century. Biffis et al (2014) report that from 2007 to 2014, there was a grand total of 25 longevity swap transactions that were publicly announced in the United Kingdom, for an average of 3 transactions per year (see also Tan et al, 2015).…”