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Title:Actuarial transform pricing PDF Logo
Authors:Ruban, Oleg
Vitiello, Luiz
Poon, Ser-Huang
Issue Date:2010
Series/Report no.:Manchester Business School working paper 592
Abstract:This article studies four transform pricing methods in the context of general equilibrium (GE) framework. The four methods, viz. the Esscher transform, indifference pricing, the Wang transform, and the standard deviation loading, are popular among actuarial literature and practice. The transform pricing methods offer a convenient solution to contingent claim pricing problem with the underlying risk exposure cannot be fully hedged. We show analytically that these four methods are similar and close to the GE approach if the utility has an exponential function, and the underlying distribution is Normal. When the payoff distribution is non-gaussian, prices produced by the four methods vary widely. Moreover, some transform methods may lead to prices that are not coherent, violating one or more of the following properties; additivity, homogeneity, scale invariance and monotonicity. We discuss the implications of our findings on incomplete market pricing.
Subjects:Esscher transform
indifference pricing
Wang transform
standard deviation loading
JEL:D52
G13
C22
Document Type:Working Paper
Appears in Collections:Manchester Business School Working Paper Series, The University of Manchester

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