EOM Exercise

[karamalz]

Task 1 ask us to describe the difference between LN and RSLN, also indicate why one model may be more conservative, also it said in determining the price for the guarantee, the LN model was used.

So I wonder does it mean that LN model is more conservative than RSLN model ???

[jraven]

Originally Posted by karamalz

Task 1 ask us to describe the difference between LN and RSLN, also indicate why one model may be more conservative, also it said in determining the price for the guarantee, the LN model was used.

So I wonder does it mean that LN model is more conservative than RSLN model ???

No. However it could mean that the pricing people are stupid.

[Laurelinda]

Originally Posted by jraven

No. However it could mean that the pricing people are stupid.

karamalz, if you haven't read the assigned reading from Hardy for this module, I would strongly recommend it. Hardy directly addresses most of the material in this assignment.

[karamalz]

Originally Posted by jraven

Oops. I should've checked my work more carefully before posting. The book's right, it's -- or alternatively . I was thinking of the formula in terms of the fund value instead of the stock value. (The formula for the price of the GMMB in terms of the fund value is exactly that for a call option on a dividend paying asset.)

Thanks for answering me lots of questions, it really help~~
But I still can't figure out why can

St(1 - mc)^2 equal to F_{t-}(1 - mc)^{2 - (t/12)}


Can someone please explain it
Thank you very very much !!!

[Laurelinda]

Originally Posted by karamalz

But I still can't figure out why can

St(1 - mc)^2 equal to F_{t-}(1 - mc)^{2 - (t/12)}

The fund value equals the stock (or index) value discounted for the management fee.

For example, if you assessed a 0.25% management fee each year, you would have F3 = S3 x (1-0.25%)^3 at the end of three years. Or equivalently, S3 = F3 x (1-0.25%)^(-3).

I haven't looked back at the assignment to see what the real numbers are, if they're per month or per year, etc. The general rule should apply, though. Does that help?

Read Hardy! I'm serious!

[Furballz]

Originally Posted by jraven

The assignment states the hedge is constructed using a volatility of 0.18, not 0.17958. That's minor, though.

The more important issue is why you have a (1-mc)^2 term in your d1 formula. As I recall it should be where mc = 0.25% and t is the month (the charge gets applied each month); that means it should be initially and

I had made the same mistake - thanks!

[mathalex]

I'm wondering if Megalon would even want to hedge under these simulations. I'm modeling the cost of the GMMB assuming that Megalon does not use any dynamic hedging, using the following formula:

NPV = max(1000 - Fund@time24,0)*exp(-.005*24)

When I do this, and run it through all scenarios (RSLN and LN), I get the following:

Under RSLN:
All statistics without the hedge are less than with the hedge

Under LN:
mean, STD, and CTE(90) are slightly less with hedge
CTE(80) is slightly more with hedge.

Has anyone else looked at it like this? Anyone disagree with my analysis?

Thanks

[mathalex]

Originally Posted by mathalex

I'm wondering if Megalon would even want to hedge under these simulations. I'm modeling the cost of the GMMB assuming that Megalon does not use any dynamic hedging, using the following formula:

NPV = max(1000 - Fund@time24,0)*exp(-.005*24)

When I do this, and run it through all scenarios (RSLN and LN), I get the following:

Under RSLN:
All statistics without the hedge are less than with the hedge

Under LN:
mean, STD, and CTE(90) are slightly less with hedge
CTE(80) is slightly more with hedge.

Has anyone else looked at it like this? Anyone disagree with my analysis?

Thanks

Ok. Nevermind, figured it out. They should definitely hedge.

[thomasling]

I just finished the task 1 of EOM. I don't understand the questions of task 2. Is it asking the impact of hedging under different parties' points of views? How's related to violation of MM?

[Laurelinda]

Originally Posted by thomasling

I just finished the task 1 of EOM. I don't understand the questions of task 2. Is it asking the impact of hedging under different parties' points of views? How's related to violation of MM?

Hi thomasling, I'm sorry if this post comes too late to help you.

What does MM say? Given the assumptions of an MM world, shareholders don't care whether or not you diversify the company's risk profile, because they can do it themselves if you don't. Now substitute "hedge" for "diversify". If the assumptions of MM are true, the company doesn't need to hedge.

But are they true? In what ways are they not true? (What are the assumptions of MM?)

If you're still working on it, I hope that helps a little.