Abstract
We model and quantify counterparty credit risk for K-forward, a newly proposed longevity-linked security. We focus on the evaluation of credit value adjustment (CVA) from the longevity risk hedger’s perspective. The modelling involves two folds. First, we use a vector autoregressive integrated moving-average process to model the time series of mortality indexes that is obtained by applying the original Cairns–Blake–Dowd model. Then, the risk-neutral default probability of the hedge provider is obtained by calibrating a reduced-form default model on the market price of bonds issued by the hedge provider. We calculate and compare CVA in K-forwards for different combinations of hedger provider, reference year and recovery rate.
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