Impact of volatility clustering on equity indexed annuities

Abstract

This study analyses the impact of volatility clustering in stock markets on the evaluation and risk management of equity indexed annuities (EIA). To introduce clustering in equity returns, the reference index is modelled by a diffusion combined with a bivariate self-excited jump process. We infer a semi-closed form or parametric expression of the moment generating functions in this framework for the equity return and the intensities of jumps. An econometric procedure is proposed to fit the model to a time series. Next, we develop a method, based on a normal inverse Gaussian approximation of the index return, to evaluate options embedded in simple variable annuities. To conclude, we compare prices, one-year value at risks, and tail value at risks of simple EIAs, computed with different models.