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Correlated regime-switching raises guaranteed annuity option prices

A man in a white shirt sits at a desk in a modern office, writing on a clipboard while reviewing financial charts displayed on multiple computer monitors showing investment data and market trends.
Research area:Actuarial scienceStochastic processes and financial applicationsInsurance, Mortality, Demography, Risk Management

What the study found

Modeling interest rates and mortality together, with correlation and regime-switching, leads to higher guaranteed annuity option (GAO) prices than conventional one-state models. The authors also present a semi-analytic pricing method that is computationally more efficient than standard Monte Carlo simulation.

Why the authors say this matters

The authors say accurate valuation of GAOs is essential for solvency assessment and risk management. They also conclude that the framework is practically relevant for managing longevity-linked guarantees under economic and demographic uncertainty.

What the researchers tested

The researchers developed a pricing framework for GAOs that jointly models interest rates and mortality rates as correlated stochastic processes with regime-switching dynamics controlled by a finite-state continuous-time Markov chain. They estimated model parameters using U.S. interest rates and cohort mortality data with quasi-maximum likelihood estimation, and derived a semi-analytic valuation formula based on the joint distribution of the processes.

What worked and what didn't

The numerical results show that including correlation and regime-switching materially increases GAO prices relative to one-state models. The semi-analytic approach provides substantial computational advantages over standard Monte Carlo simulations. Sensitivity analysis identified the parameters most relevant for long-horizon pricing and solvency considerations.

What to keep in mind

The abstract does not describe specific numerical estimates, model limitations, or validation beyond the reported numerical results and sensitivity analysis. It also does not provide details on the scope of the data beyond U.S. interest rates and cohort mortality data.

Key points

  • Guaranteed annuity option prices were higher when interest rates and mortality were modeled jointly with correlation and regime-switching.
  • The paper proposes a semi-analytic pricing formula for GAOs.
  • The semi-analytic method is reported to be more computationally efficient than standard Monte Carlo simulation.
  • Model parameters were estimated using U.S. interest rates and cohort mortality data.
  • Sensitivity analysis identified parameters most relevant for long-horizon pricing and solvency considerations.

Disclosure

Research title:
Correlated regime-switching raises guaranteed annuity option prices
Publication date:
2026-02-23
DOI:
10.3390/risks14020042
OpenAlex record:
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AI provenance: AI provenance information is not available for this post.

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