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

DOI10.1007/S00780-019-00408-0MaRDI QIDQ2282964zbMATH OpenOpenAlexWikidataFDO

Authors Hampus Engsner, Kristoffer Lindensjö, Filip Lindskog

Publication date 27 December 2019

Published in Finance and Stochastics (Search for Journal in Brave)

Copyright license Creative Commons Attribution 4.0 International

Full work available at URL https://arxiv.org/abs/1808.03328

zbMATH Keywords

capital requirementsmarket-consistent valuationreplicating portfolios

Mathematics Subject Classification ID

Stopping times; optimal stopping problems; gambling theory (60G40) Actuarial mathematics (91G05) Portfolio theory (91G10) Corporate finance (dividends, real options, etc.) (91G50)

Abstract: The aim of this paper is to define the market-consistent multi-period value of an insurance liability cash flow in discrete time subject to repeated capital requirements, and explore its properties. In line with current regulatory frameworks, the approach presented is based on a hypothetical transfer of the original liability and a replicating portfolio to an empty corporate entity whose owner must comply with repeated one-period capital requirements but has the option to terminate the ownership at any time. The value of the liability is defined as the no-arbitrage price of the cash flow to the policyholders, optimally stopped from the owner's perspective, taking capital requirements into account. The value is computed as the solution to a sequence of coupled optimal stopping problems or, equivalently, as the solution to a backward recursion.

Review text

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.

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Cited in

(11)

• Continuous-time limits of multi-period cost-of-capital margins
• Financial position and performance in IFRS 17
• Insurance valuation: a computable multi-period cost-of-capital approach
• Insurance valuation: A two-step generalised regression approach
• Valuation of hybrid financial and actuarial products in life insurance by a novel three-step method
• Fair valuation of insurance liability cash-flow streams in continuous time: applications
• Multiple-prior valuation of cash flows subject to capital requirements
• New challenges in the interplay between finance and insurance. Abstracts from the workshop held October 1--6, 2023
• Insurance-finance arbitrage
• A framework for the valuation of insurance liabilities by production cost
• On deposit volumes and the valuation of non-maturing liabilities

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