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


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