Vega Maps: New Methods for Quantifying Vega Risk of VAs & FIAs
Equity-based insurance guarantees such as variable annuities (VAs) and fixed indexed annuities (FIAs) can be very sensitive to changes in the implied volatility of the underlying assets, and insurers frequently hedge these exposures through vega hedging.
While vega profiles for vanilla derivatives can be easily determined, more advanced methods may be required for VAs since they are not only sensitive to parallel movements in implied volatilities, but to changes in the shape of the implied volatility surface as well. These non-parallel shifts or twists may span the volatility term structure, and include shifts in skew and smile. Firms engaged in dynamic hedging of FIA credits are also exposed to similar movements in implied volatilities.
When using Monte Carlo methods for risk-neutral valuations, many firms employ stochastic volatility models that capture the term structure and skew of implied volatility. While these models improve market consistent valuations, they introduce challenges when trying to determine vega risk buckets. Shifting individual points on the implied volatility surface may introduce arbitrage and/or model calibration difficulties.
On Wednesday, February 18th, 2015 featured speaker Alex Marion, Vice President of Product Management at Numerix, introduced a new framework for mapping vega risk of VAs and FIAs to allow for bucketing vega risk by tenor, as well as measuring sensitivity to changes in skew and smile. The combination of the sensitivities produces a vega map profile that allows for more efficient replication of vega risk using vanilla options.
Mr. Marion covered:
- Examples where parallel vega hedging is insufficient
- Primer on stochastic volatility models
- Bucketing vega risk by tenor
- Measuring sensitivity to changes in volatility skew and smile
- Optimizing hedges based on non-parallel shifts in the volatility surface
- Applications in FIA and VA hedging
Featured Speakers
Alex Marion
Alex Marion heads up insurance solutions for the Numerix Client Services group as VP of Product Management. In this role he works with clients developing comprehensive risk management solutions, leveraging powerful analytics and actuarial expertise. Mr. Marion and his team of actuaries and financial engineers provide solutions in dynamic hedging, economic scenario generation, asset liability management, nested stochastics, counterparty risk, and regulatory compliance.
Prior to joining Numerix, Mr. Marion served as a quantitative analyst for Phoenix Wealth Management where he developed a risk-neutral economic scenario generator with applications in VA and EIA dynamic hedging. Before Phoenix, Mr. Marion was a consultant with Milliman’s Financial Risk Management practice where he managed dynamic hedging strategies for insurers.
As Chief Marketing Officer and Executive Vice President of Global Marketing & Corporate Communications, James leads the company’s global marketing and corporate communications efforts, spanning a diverse set of solutions and audiences. He oversees integrated marketing communications to clients in the largest global financial markets and to the Numerix partner network through the company's branding, electronic marketing, research, events, public relations, advertising and relationship marketing.
Since joining Numerix in 2008, James has launched the organization’s award-winning thought leadership program, bringing to light challenges and insights from Numerix market experts. He also hosts the Numerix Video Blog, tackling the challenges pressing the derivatives markets—from regulatory issues to trading strategies.
Prior to joining Numerix, James served as Managing Director of Global Marketing and Communications for Fitch Ratings. During his tenure at Fitch, he built the firm’s public relations program, oversaw investor relations and led marketing and communications plans for several acquisitions. Prior to Fitch, James was a member of the communications team at Moody's Investors Service.
