Skip to main content Accessibility help
×
Hostname: page-component-78c5997874-8bhkd Total loading time: 0 Render date: 2024-11-07T20:36:28.419Z Has data issue: false hasContentIssue false
This chapter is part of a book that is no longer available to purchase from Cambridge Core

10 - Interest rate risk

David C. M. Dickson
Affiliation:
University of Melbourne
Mary R. Hardy
Affiliation:
University of Waterloo, Ontario
Howard R. Waters
Affiliation:
Heriot-Watt University, Edinburgh
Get access

Summary

Summary

In this chapter we consider the effect on annuity and insurance valuation of interest rates varying with the duration of investment, as summarized by a yield curve, and of uncertainty over future interest rates, which we will model using stochastic interest rates. We introduce the concepts of diversifiable and non-diversifiable risk and give conditions under which mortality risk can be considered to be diversifiable. In the final section we demonstrate the use of Monte Carlo methods to explore distributions of uncertain cash flows and loss random variables through simulation of both future lifetimes and future interest rates.

The yield curve

In practice, at any given time interest rates vary with the duration of the investment; that is, a sum invested for a period of, say, five years, would typically earn a different rate of interest than a sum invested for a period of 15 years or a sum invested for a period of six months.

Let v(t) denote the current market price of a t year zero-coupon bond; that is, the current market price of an investment which pays a unit amount with certainty t years from now. Note that, at least in principle, there is no uncertainty over the value of v(t) although this value can change at any time as a result of trading in the market.

Type
Chapter
Information
Publisher: Cambridge University Press
Print publication year: 2009

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Save book to Kindle

To save this book to your Kindle, first ensure [email protected] is added to your Approved Personal Document E-mail List under your Personal Document Settings on the Manage Your Content and Devices page of your Amazon account. Then enter the ‘name’ part of your Kindle email address below. Find out more about saving to your Kindle.

Note you can select to save to either the @free.kindle.com or @kindle.com variations. ‘@free.kindle.com’ emails are free but can only be saved to your device when it is connected to wi-fi. ‘@kindle.com’ emails can be delivered even when you are not connected to wi-fi, but note that service fees apply.

Find out more about the Kindle Personal Document Service.

Available formats
×

Save book to Dropbox

To save content items to your account, please confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your account. Find out more about saving content to Dropbox.

Available formats
×

Save book to Google Drive

To save content items to your account, please confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your account. Find out more about saving content to Google Drive.

Available formats
×