Skip to main content
×
×
Home

A Multivariate Model of Strategic Asset Allocation with Longevity Risk

  • Emilio Bisetti, Carlo A. Favero, Giacomo Nocera and Claudio Tebaldi
Abstract

Population-wide increase in life expectancy is a source of aggregate risk. Longevity-linked securities are a natural instrument to reallocate that risk. This paper extends the standard Campbell–Viceira (2005) strategic asset allocation model by including a longevity-linked investment possibility. Model estimation, based on prices for standardized annuities publicly offered by U.S. insurance companies, shows that aggregate shocks to survival probabilities are predictors for long-term returns of the longevity-linked securities, and reveals an unexpected predictability pattern. Valuation of longevity risk premium confirms that longevity-linked securities offer inexpensive funding opportunities to asset managers.

Copyright
Corresponding author
* Bisetti, bisetti@cmu.edu, Tepper School of Business, Carnegie Mellon University; Favero (corresponding author), carlo.favero@unibocconi.it, Università L. Bocconi and the Innocenzo Gasparini Institute for Economic Research (IGIER); Nocera, gnocera@audencia.com, Audencia Business School; and Tebaldi, claudio.tebaldi@unibocconi.it, Bocconi University, IGIER, and the Center for Applied Research in Finance (CAREFIN).
Footnotes
Hide All
1

We thank an anonymous referee, Enrico Biffis, Stephen Brown (the editor), Burton Hollifield, and Sergio Paci for valuable comments, the participants to the 2015 WU Gutmann Center Symposium: Retirement and Asset Management and the discussant Marcel Fischer, the participants to the 2015 International Pension Workshop Netspar in Amsterdam, and in particular Bertrand Melenberg (the discussant) for useful insights. The usual disclaimer applies. This paper was initially submitted on May 8, 2015.

Footnotes
References
Hide All
Barberis, N.Investing for the Long Run When Returns Are Predictable.” Journal of Finance, 55 (2000), 225264.
Bayraktar, E.; Milevsky, M. A.; Promislow, S. D.; and Young, V. R.. “Valuation of Mortality Risk via the Instantaneous Sharpe Ratio: Applications to Life Annuities.” Journal of Economic Dynamics and Control, 33 (2009), 676691.
Biffis, E., and Blake, D.. “Securitizing and Tranching Longevity Exposures.” Insurance: Mathematics and Economics, 46 (2010), 186197.
Biffis, E.; Denuit, M.; and Devolder, P.. “Stochastic Mortality under Measure Changes.” Scandinavian Actuarial Journal, 2010 (2010), 284311.
Blake, D., and Burrows, W.. “Survivor Bonds: Helping to Hedge Mortality Risk.” Journal of Risk and Insurance, 68 (2001), 339348.
Blake, D.; Cairns, A.; Coughlan, G.; and Dowd, K.. “The New Life Market.” Journal of Risk and Insurance, 80 (2013), 501557.
Blake, D.; Cairns, A.; and Dowd, K.. “A Two-Factor Model for Stochastic Mortality with Parameter Uncertainty: Theory and Calibration.” Journal of Risk and Insurance, 73 (2006), 683718.
Campbell, J. Y.Understanding Risk and Return.” Journal of Political Economy, 104 (1996), 298345.
Campbell, J. Y.; Chan, Y. L.; and Viceira, L. M.. “A Multivariate Model of Strategic Asset Allocation.” Journal of Financial Economics, 67 (2003), 4180.
Campbell, J. Y., and Viceira, L. M.. Strategic Asset Allocation: Portfolio Choice for Long-Term Investors. New York, NY: Oxford University Press (2002).
Campbell, J. Y., and Viceira, L. M.. “The Term Structure of the Risk–Return Trade-Off.” Financial Analysts Journal, 61 (2005), 3444.
Cocco, J. F., and Gomes, F. J.. “Longevity Risk, Retirement Savings, and Financial Innovation.” Journal of Financial Economics, 103 (2012), 507529.
Fama, E. F., and Bliss, R. R.. “The Information in Long-Maturity Forward Rates.” American Economic Review, 77 (1987), 680692.
Finkelstein, A., and Poterba, J. M.. “Selection in Insurance Markets: Policyholder Evidence from the U.K. Annuity Market.” Journal of Political Economy, 112 (2004), 183208.
Frazzini, A.; Kabiller, D.; and Pedersen, L. H.. “Buffett’s Alpha.” Technical Report, National Bureau of Economic Research (2013).
Friedberg, L., and Webb, A.. “Life Is Cheap: Using Mortality Bonds to Hedge Aggregate Mortality Risk.” B.E. Journal of Economic Analysis & Policy, 7 (2007), Article 31.
Horneff, R. H.; Maurer, W. J.; Mitchell, O. S.; and Stamos, M. Z.. “Asset Allocation and Location over the Life Cycle with Survival-Contingent Payouts.” Journal of Banking & Finance, 33 (2009), 16881699.
Koijen, R. S., and Yogo, M.. “Shadow Insurance.” Econometrica, 84 (2016), 12651287.
Lee, R. D.The Lee–Carter Method for Forecasting Mortality, with Various Extensions and Applications.” North American Actuarial Journal, 4 (2000), 8093.
Lee, R. D., and Carter, L. R.. “Modeling and Forecasting U.S. Mortality.” Journal of the American Statistical Association, 87 (1992), 659671.
Lin, Y., and Cox, S. H.. “Securitization of Mortality Risks in Life Annuities.” Journal of Risk and Insurance, 72 (2005), 227252.
Lin, Y., and Cox, S. H.. “Securitization of Catastrophe Mortality Risks.” Insurance: Mathematics and Economics, 42 (2008), 628637.
Loeys, J.; Panigirtzoglou, N.; and Ribeiro, R. M.. “Longevity: A Market in the Making.” Technical Report, J. P. Morgan Global Market Strategy 2007.
Markowitz, H.Portfolio Selection.” Journal of Finance, 7 (1952), 7791.
Mehra, R., and Prescott, E. C.. “The Equity Premium: A Puzzle.” Journal of Monetary Economics, 15 (1985), 145161.
Merton, R. C.An Intertemporal Capital Asset Pricing Model.” Econometrica, 41 (1973), 867887.
Milevsky, M. A. The Calculus of Retirement Income. Cambridge, UK: Cambridge University Press (2006).
Milevsky, M. A.; Promislow, S. D.; and Young, V. R.. Financial Valuation of Mortality Risk via the Instantaneous Sharpe Ratio. Toronto, Canada: IFID Center (2006).
Milevsky, M. A.; Promislow, S. D.; and Young, V. R.. “Killing the Law of Large Numbers: Mortality Risk Premiums and the Sharpe Ratio.” Journal of Risk and Insurance, 73 (2006), 673686.
Mitchell, O. S.; Poterba, J. M.; Warshawsky, M. J.; and Brown, J. R.. “New Evidence on the Money’s Worth of Individual Annuities.” American Economic Review, 89 (1999), 12991318.
Pitacco, E.; Denuit, M.; Haberman, S.; and Olivieri, A.. Modelling Longevity Dynamics for Pensions and Annuity Business. Oxford, UK: Oxford University Press (2009).
Poterba, J. M.The History of Annuities in the United States.” The Role of Annuity Markets in Financing Retirement. Cambridge, MA: MIT Press (2001).
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Journal of Financial and Quantitative Analysis
  • ISSN: 0022-1090
  • EISSN: 1756-6916
  • URL: /core/journals/journal-of-financial-and-quantitative-analysis
Please enter your name
Please enter a valid email address
Who would you like to send this to? *
×
Type Description Title
PDF
Supplementary materials

Bisetti et al supplementary material
Online Appendix

 PDF (353 KB)
353 KB

Metrics

Full text views

Total number of HTML views: 0
Total number of PDF views: 152 *
Loading metrics...

Abstract views

Total abstract views: 538 *
Loading metrics...

* Views captured on Cambridge Core between 31st October 2017 - 17th August 2018. This data will be updated every 24 hours.