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Computing Risk Measures of Life Insurance Policies through the Cox–Ross–Rubinstein Model

Massimo Costabile
The Journal of Derivatives Winter 2018, 26 (2) 86-94; DOI: https://doi.org/10.3905/jod.2018.26.2.086
Massimo Costabile
is a full professor in the Department of Economics, Statistics, and Finance at the University of Calabria in Rende (CS), Italy
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Abstract

The problem of computing risk measures of life insurance policies is complicated by the fact that two different probability measures, the real-world probability measure along the risk horizon and the risk-neutral one along the remaining time interval, have to be used. This implies that a straightforward application of the Monte Carlo method is not available and the need arises to resort to time consuming nested simulations or to the least squares Monte Carlo approach. We propose to compute common risk measures by using the celebrated binomial model of Cox, Ross, and Rubinstein (1979) (CRR). The main advantage of this approach is that the usual construction of the CRR model is not influenced by the change of measure and a unique lattice can be used along the whole policy duration. Numerical results highlight that the proposed algorithm computes highly accurate values.

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The Journal of Derivatives: 26 (2)
The Journal of Derivatives
Vol. 26, Issue 2
Winter 2018
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Computing Risk Measures of Life Insurance Policies through the Cox–Ross–Rubinstein Model
Massimo Costabile
The Journal of Derivatives Nov 2018, 26 (2) 86-94; DOI: 10.3905/jod.2018.26.2.086

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Computing Risk Measures of Life Insurance Policies through the Cox–Ross–Rubinstein Model
Massimo Costabile
The Journal of Derivatives Nov 2018, 26 (2) 86-94; DOI: 10.3905/jod.2018.26.2.086
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