PI - 1402 A Multivariate Model of Strategic Asset Allocation with Longevity Risk

This paper proposes a framework to evaluate the impact of longevitylinked securities on the risk-return trade-off for traditional portfolios. Generalized unexpected raise in life expectancy is a source of aggregate risk in the insurance sector balance sheets. Longevity-linked securities are a natural instrument to reallocate these risks by making them tradable in the financial market. This paper extends the strategic asset allocation model of Campbell and Viceira (2005) to include a longevity-linked investment in addition to equity and fixed income securities and describe the resulting term structure of risk-return tradeoffs. The model highlights an unexpected predictability pattern of the survival probability estimates and gives an empirical valuation of the market price of longevity risk based on the Lee and Carter (1992) mortality model and on the time series of prices for standardized annuities publicly offered by US insurance companies.