Post by Sapphire Capital on Sept 8, 2008 10:52:52 GMT 4
Securitizing and Tranching Longevity Exposures
Enrico Biffis
Tanaka Business School
David P. Blake
City University London - Cass Business School - The Pensions Institute
August 15, 2008
Abstract:
We consider the problem of optimally designing longevity risk transfers under asymmetric information. Holders of longevity exposures have superior knowledge of the underlying demographic risks, but are willing to take them off their balance sheets because of capital requirements. In equilibrium, they transfer longevity risk to uninformed agents at a cost, where the cost is represented by retention of part of the exposure and/or by a risk premium. We use a signalling model to quantify the effects of asymmetric information and emphasize how they compound with parameter uncertainty. We show how the cost of private information can be minimized by suitably tranching securitized cashflows, or, equivalently, by securitizing the exposure in exchange for an option on mortality rates. We also investigate the benefits of pooling several longevity exposures and the impact on tranching levels.
Enrico Biffis
Tanaka Business School
David P. Blake
City University London - Cass Business School - The Pensions Institute
August 15, 2008
Abstract:
We consider the problem of optimally designing longevity risk transfers under asymmetric information. Holders of longevity exposures have superior knowledge of the underlying demographic risks, but are willing to take them off their balance sheets because of capital requirements. In equilibrium, they transfer longevity risk to uninformed agents at a cost, where the cost is represented by retention of part of the exposure and/or by a risk premium. We use a signalling model to quantify the effects of asymmetric information and emphasize how they compound with parameter uncertainty. We show how the cost of private information can be minimized by suitably tranching securitized cashflows, or, equivalently, by securitizing the exposure in exchange for an option on mortality rates. We also investigate the benefits of pooling several longevity exposures and the impact on tranching levels.