A lattice approach to evaluate participating policies in a stochastic interest rate framework
In this paper, the authors propose one way to achieve the accurate evaluation and management of the risk affecting long-term life insurance contracts. They propose to consider stochastic dynamics not only for the company's assets \(S\) but also for the interest rate \(r\). It is supposed that stochastic dynamics is expressed by the following two equations \[ \begin{cases} \mathrm{d}r(t)=m(r(t))\mathrm{d}t+\sigma_r(r(t))\mathrm{d}W_t^{(r)},\\ \mathrm{d}S(t)=r(t)S(t)+\sigma_SS(t)\mathrm{d}W_t^S, \end{cases} \] where \(W^r\) and \(W^S\) are correlated Brownian motions with the correlation \(\varrho\), and \(\sigma_S\) is the equity price volatility. By specifying the drift \(m(r(t))\) and and the volatility component \(\sigma_r(r(t))\), it is possible to get different stochastic interest models. The way proposed in the paper is flexible, because it allows the insurer to choose the most appropriate dynamics both for the interest rate and the company's assets.
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