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Risks 2018, 6(3), 78; https://doi.org/10.3390/risks6030078

On Fund Mapping Regressions Applied to Segregated Funds Hedging Under Regime-Switching Dynamics

1
Faculté des Sciences de l’Administration, Université Laval, Québec, QC G1V 0A6, Canada
2
Department of Mathematics and Statistics, Concordia University, Montréal, QC H3G 1M8, Canada
3
École d’Actuariat, Université Laval, Québec, QC G1V 0A6, Canada
*
Author to whom correspondence should be addressed.
Received: 14 July 2018 / Revised: 3 August 2018 / Accepted: 8 August 2018 / Published: 10 August 2018
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Abstract

Insurers issuing segregated fund policies apply dynamic hedging to mitigate risks related to guarantees embedded in such policies. A typical industry practice consists of using fund mapping regressions to represent basis risk stemming from the imperfect correlation between the underlying fund and its corresponding hedging instruments. The current work discusses the implications of using fund mapping regressions when the joint dynamics of the underlying and hedging assets is a regime-switching process. The potential underestimation of capital requirements stemming from the use of a fund mapping regression under such dynamics is discussed. The magnitude of the latter phenomenon is quantified through simulations calibrated on market data. View Full-Text
Keywords: basis risk; hedging; segregated funds; variable annuities; risk measures; risk management; regime-switching basis risk; hedging; segregated funds; variable annuities; risk measures; risk management; regime-switching
This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. (CC BY 4.0).
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MDPI and ACS Style

Trottier, D.-A.; Godin, F.; Hamel, E. On Fund Mapping Regressions Applied to Segregated Funds Hedging Under Regime-Switching Dynamics. Risks 2018, 6, 78.

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