Abstract
The cost of maturity minimum guarantee of an investment fund is typically deducted upfront or at the beginning of each period, together with other costs such as sales commissions and management fees. This practice gives a significant negative impact on the short term returns of the investment. In this paper, we propose a way to compensate the cost of investment guarantee by continuous withdrawals whenever the fund value stays below or at a predetermined threshold. The corresponding dynamics of fund price follows a (geometric) refracted Brownian motion, where the two drifts are state dependent. We derive integral formulas for the prices of fund and maturity minimum guarantee. Given the cost deduction threshold and the maturity guarantee level, the fair deduction rate can be determined numerically.
Similar content being viewed by others
References
T. Bae and B. Ko, The Korean Journal of Applied Statistics 23(4), 621 (2010).
P. P. Boyle and M. R. Hardy, Insurance: Mathematics and Economics 21, 113 (1997).
M. R. Hardy, North American Actuarial Journal 4, 63 (2000).
M. R. Hardy, Investment Guarantees: Modelling and Risk Management for Equity-Linked Life Insurance (Wiley, New York, 2003).
H. Gerber and E. Shiu, Journal of Computational and Applied Mathematics 186, 4 (2006).
I. Karatzas and S. E. Shreve, Brownian Motion and Stochastic Calculus, 2nd Edition (Springer, New York, 1997).
A. E. Kyprianou and R. L. Loeffen, Annales de l’Institut Henri Poincaré 46(1), 24 (2010).
M. Musiela and M. Rutkowski, Martingale Methods in Financial Modelling, 2nd Edition (Springer-Verlag, Berlin, 2005).
S. E. Shreve, Stochastic Calculus for Finance II: Continuous-Time Models (Springer, New York, 2004).
Author information
Authors and Affiliations
Corresponding author
Additional information
(Submitted by A. I. Volodin)
T. Bae is supported by a startup grant from the University of Regina.
Rights and permissions
About this article
Cite this article
Bae, T., Ko, B. Pricing maturity guarantee under a refracted Brownian motion. Lobachevskii J Math 34, 234–247 (2013). https://doi.org/10.1134/S1995080213030025
Published:
Issue Date:
DOI: https://doi.org/10.1134/S1995080213030025