Date of Award

7-31-2016

Degree Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Department

Risk Management and Insurance

First Advisor

Daniel Bauer

Second Advisor

Ajay Subramanian

Third Advisor

Enrico Biffis

Fourth Advisor

Baozhong Yang

Abstract

This dissertation consists of two chapters. The first chapter establishes an algorithm for calculating capital requirements. The calculation of capital requirements for financial institutions usually entails a reevaluation of the company's assets and liabilities at some future point in time for a (large) number of stochastic forecasts of economic and firm-specific variables. The complexity of this nested valuation problem leads many companies to struggle with the implementation. The current chapter proposes and analyzes a novel approach to this computational problem based on least-squares regression and Monte Carlo simulations. Our approach is motivated by a well-known method for pricing non-European derivatives. We study convergence of the algorithm and analyze the resulting estimate for practically important risk measures. Moreover, we address the problem of how to choose the regressors, and show that an optimal choice is given by the left singular functions of the corresponding valuation operator. Our numerical examples demonstrate that the algorithm can produce accurate results at relatively low computational costs, particularly when relying on the optimal basis functions. The second chapter discusses another application of regression-based methods, in the context of pricing variable annuities. Advanced life insurance products with exercise-dependent financial guarantees present challenging problems in view of pricing and risk management. In particular, due to the complexity of the guarantees and since practical valuation frameworks include a variety of stochastic risk factors, conventional methods that are based on the discretization of the underlying (Markov) state space may not be feasible. As a practical alternative, this chapter explores the applicability of Least-Squares Monte Carlo (LSM) methods familiar from American option pricing in this context. Unlike previous literature we consider optionality beyond surrendering the contract, where we focus on popular withdrawal benefits - so-called GMWBs - within Variable Annuities. We introduce different LSM variants, particularly the regression-now and regression-later approaches, and explore their viability and potential pitfalls. We commence our numerical analysis in a basic Black-Scholes framework, where we compare the LSM results to those from a discretization approach. We then extend the model to include various relevant risk factors and compare the results to those from the basic framework.

DOI

https://doi.org/10.57709/8842411

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