Abstract
In this article, we propose a model of optimal insurance pricing and investment strategies, in which the insurance price, investment returns and insured losses are assumed to be correlated stochastic processes. The investment portfolio discussed in this paper contains more than one risky assets following multi-Vasicek model with time-varying correlation. To solve the optimal investment problem, we take into account the demand of insurance contracts which impacts the price of the contracts; the utility is a performance process for a specific time; we determine dynamical optimal price of an insurance contract and the optimal investment portfolio of an insurer simultaneously by maximizing the performance of the insurer. We carry out numerical analysis with an example. The results show that the Treasury Bill, generally considered as a risk-free asset, is examined to follow the similar pattern as other risky assets in terms of volatility/mean ratio; multi-Vasicek model is an appropriate model to describe the change pattern of the return of risky assets in the investment. We analyze the sensitivity of the change in important parameters of the optimal solutions. It is worth noticing that the equally weighted investment portfolio is proved to be an optimal investment strategy under some conditions; the proposed model in this paper can be used to obtain optimal solutions easily in the situation of multi-dimensional investment portfolio.
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Notes
Although Eq. (16) is similar in form to that presented by Zhang and Siu (2009, Eq. (4.6)), it actually is different from that of Zhang and Siu (2009). Zhang and Siu (2009) trial exponential utility function (4.6) is a uitlity function of state independence. It includes a fictious variable expressed as a market opponent which is only necessary in stochastic differential game framework. Their optimization problem is established in backward time. However, we use the forward performance process of state dependence including dynamic return process of investment portfolio and price process without the fictious variable, our optimization problem is non-Makovian and is in forward time.
In general, optimizing over amount of risky assets is equivalent to optimizing over proportion of risky assets if only one kind of risky assets is considered. However, when multi-risky assets are considered at the same time and claim risk and the risk of the change of market price are integreated into consideration, optimizing over total assets (total wealth) is different from optimizing over the proportions of all kinds of risky assets invested.
In Eq. (22) and all other relevant equations, \( f_{t} \) represents \( \tfrac{\partial f(t)}{\partial t} \) for convenience and \( \phi \)’s with subscripts such as \( x \),\( t \) and \( \bar{p} \) are partial differentials with regards to the subscripts. Please note that all other variables with subscript t mean that they are functions of time t.
Superscript “*” indicates that the supercribed parameters stand for optimal values.
Please note that subscript t is omitted for \( \Xi \),\( p \),\( q \),\( k \),\( a \) in all expressions for the first order conditions. \( \mu_{r} (t) \) is simplied as \( \mu_{r} \) and \( \sigma_{r} (t) \) as \( \sigma_{r} \). .
\( \delta \) method introduced in Gourieroux and Jasiak (2001, Sect. 12.1.2) is used to estimate the error when historical data is applied to fit Multi-Vasicek model. Please note Gourieroux and Jasiak (2001, Sect. 12.1.2) only gives the formulas for estimating the asymptotic variances of parameters of \( a \) and \( b \). The formula for the asymptotic variance \( V(\hat{\sigma }_{T} ) \) in Vasicek model is as following: \( V(\hat{\sigma }_{T} ) = \left( {\tfrac{\partial }{\partial \rho }\sqrt {\hat{\sigma }_{T} } } \right)^{2} = \left( {\tfrac{{1/(\rho (1 - \rho^{2} ) + 2\rho \ln (\rho )}}{{(1 - \rho^{2} )\sqrt { - \tfrac{2\ln (\rho )}{{1 - \rho {}^{2}}}} }}} \right)^{2} V(\hat{\eta }_{T} ) \), where \( \rho \) and \( \eta_{T} \) satisfy equations of (12.11) in Gourieroux and Jasiak (2001, Sect. 12.1.2) and \( V(\hat{\eta }_{T} ) = \tfrac{{2\hat{\eta }_{T}^{4} }}{T} \), \( T \) is sample size.
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Appendix
Appendix
We calculate \( \sigma_{ij} (t) \), the time-varying covariance of the returns of \( i \)th and \( j \)th risky
Assets, in a manner similar to Korn and Koziol (2006), and Mamon (2004):
where subscript \( u \) stands for the time and the subscript \( i \) for the \( i \)th risky asset.
In the following, we calculate the time-varying covariance, \( \sigma_{ij} (t) \) for \( i \)th and \( j \)th risky assets. By Itô isometry, we have:
Please note that \( \sigma_{i}^{2} (t) = \sigma_{ij} (t) \); when \( i = j \), \( \sigma_{i}^{2} (t) = \frac{{\sigma_{i}^{2} }}{{2a_{i} }}\left( {1 - e^{{ - 2a_{i} t}} } \right). \)
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Mao, H., Wen, Z. Optimal Decision on Dynamic Insurance Price and Investment Portfolio of an Insurer with Multi-dimensional Time-Varying Correlation. J. Quant. Econ. 18, 29–51 (2020). https://doi.org/10.1007/s40953-019-00170-2
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DOI: https://doi.org/10.1007/s40953-019-00170-2
Keywords
- Stochastic process
- Multi-Vasicek model
- Time-varying correlation of Multi-Gaussian process
- Insurance demand and price
- Equally weighted risky asset portfolio