The value of a liability cash flow in discrete time subject to capital requirements (Q2282964)

The paper defines the market-consistent multi-period value of a liability cash flow in discrete time subject to repeated capital requirements in accordance with current regulatory frameworks, and explore its properties. The general liability valuation framework is presented first, and then the three main ingredients/features of the paper are introduced: (1) the value of ownership of the reference undertaking is defined, consistently with classical financial arbitrage valuation, as the no-arbitrage value of the optimally stopped (discounted) net cash flow to the owner of the reference undertaking; (2) the value of the liability is defined as the no-arbitrage value of the (discounted) cash flow to the policyholders, stopped optimally from the perspective of the owner of the reference undertaking; and (3) these definitions are shown to be equivalent to two coupled backward recursions for the two values in (1) and (2), and the optimal stopping times are determined explicitly. The valuation framework in the paper is the first one that combines all the above features consistently with the underlying principles of the current regulatory frameworks.