Natural hedging with fix and floating strike guarantees

We analyze minimum return rate guarantees including fixed guarantee rates prevailing for the whole contract horizon and floating guarantee rates linked to the interest rate evolution. In a complete arbitrage free market, we... [ view full abstract ]

We analyze minimum return rate guarantees including fixed guarantee rates prevailing for the whole contract horizon and floating guarantee rates linked to the interest rate evolution. In a complete arbitrage free market, we obtain closed form pricing solutions for both guarantees. Different guarantee costs are explained by the difference of the arbitrage free values of the guarantee schemes and the difference between cumulated volatilities resulting from forward and simple volatilities. We analyze the sensitivities of the asset and liability side against interest rate changes. A combination of fix price and floating strike guarantees enables natural hedging against interest rate changes.