2008 Investment Symposium Zhang 3 24 08

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Managing a FIA hedging program

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  • To mimic the type of options (put or call) and the distributions of option tenors (years to maturity), given the fact that we don’t yet have a true hedging projection system (Pegasus Release 2), we have built two simplified liability portfolios – one for VA and one for FIA. See appendix for details. To compare the results of different trading rules tested, we selected a few bad market crash windows during the last 20 years, including the worst equity crash of 1987, for tail events. We build a 20-year historical data bank to incorporate price/dividend data, swap curves movements, and volatility surface movements. To truly test the trading rule as it would be experienced during the trading days, it is required to look at the changes during the trading days, not just looking at the daily closing prices. Except for the most recent days, we constructed daily “ticks” using Brownian Bridge method that made the testing much more robust and realistic. The daily tick data greatly enhanced our data history. See appendix for more details of the “Brownian Bridge” methodology. Our main criteria are transaction costs, hedge effectiveness, performance in tail events. Due to the complexity of the system and multiple criteria for selecting a good trading rule, we will use the graph to assist our comparison of the testing cases.
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