Dynamic surplus optimization with performance- and index-linked liabilities
Sascha Desmettre1, Markus Wahl2, Rudi Zagst2
1Johannes Kepler University Linz, Altenberger Straße 69, 4040 Linz, Austria.
European Actuarial Journal
|November 29, 2022
Summary
Liability-driven investment strategies face challenges. This study develops a flexible framework for optimizing portfolios with dynamic strategies and stochastic liabilities, finding that linked liabilities increase risky asset allocation while unhedgeable risks decrease it.
Area of Science:
- Finance
- Actuarial Science
- Quantitative Finance
Background:
- The rise of liability-driven investment (LDI) strategies and retirement products with variable guarantees presents challenges for portfolio optimization.
- Existing frameworks struggle to incorporate dynamic investment strategies and stochastic liabilities effectively.
Purpose of the Study:
- To develop a general and flexible terminal surplus optimization framework in continuous time.
- To allow for dynamic investment strategies and stochastic liabilities linked to market performance.
- To derive optimal investment strategies for various liability models.
Main Methods:
- Established a continuous-time terminal surplus optimization framework.
- Developed closed-form solutions for optimal investment strategies under different liability models.
- Conducted numerical examples to analyze key parameters.
Main Results:
- Performance- or index-linked liabilities enable higher allocation to risky assets by closely aligning company wealth with liabilities.
- Unhedgeable risks necessitate a reduced allocation to risky investments.
- The relative risk aversion parameter influences investment decisions.
Conclusions:
- Insurance companies should link product performance closely to wealth to enhance policyholder returns.
- Minimizing unhedgeable risks is crucial for optimizing investment strategies.
- The developed framework provides flexibility for dynamic LDI strategies.
Keywords:
Asset-liability managementMartingale methodPerformance participationRandom utilityStochastic liabilitiesSurplus optimizationMore Related Videos
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