Kevin Krahe, Michael Sherris, Andrés M. Villegas and Jonathan Ziveyi
Abstract: We develop and assess a value-based longevity index that closely tracks the value of longevity-linked liabilities with the potential to signicantly lower the costs and improve the efficiency of index-based longevity hedging techniques relative to standard mortality rate indices, currently referenced in financial markets. As the US is one of the largest countries in terms of market potential for such an index, we use US economic and population data to demonstrate that hedging with our proposed index generates a material reduction in basis risk relative to indices based purely on mortality rates. This is aided by the use of a multi-population continuous-time affine mortality model and a dynamic Nelson-Siegel model for interest rates. We allow both interest rate and ination risks to impact the value of longevity-linked liabilities in our longevity risk hedging. We also bridge the gap between continuous-time and discrete-time multi-population mortality models and show that the continuous-time models are as effective in hedging liabilities as the often used discrete-time models, while being more familiar to nancial market participants.
Keywords: Value-based longevity index, longevity risk, interest rate risk, inflation risk, longevity basis risk, longevity hedging
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