Valuation of Payment Processes in the Presence of Realistically Asymmetric Taxes on Investment Returns

Specialforsvar ved Mikkel Anker Lilja

Titel: Valuation of Payment Processes in the Presence of Realistically Asymmetric Taxes on Investment Returns

 Abstract: The Solvency 2 regulations require insurance companies to model future taxes, which usually depend on how the companies choose to invests. In addition to the payment process defined in a given contract, companies therefore face additional cash flows corresponding to taxes, which depend on the hedging strategy. This thesis studies the problem of valuation and hedging of payment processes in the presence of such tax cash flows, which has, to the author’s knowledge, previously only been studied in the case where taxes are paid continuously as a fraction of the investment returns. We review the semi-explicit results for the hedging strategy obtained in this recent literature, and further discover that under more realistic tax models the valuation and hedging is a significantly more complex problem to solve. Thereafter, we study how much companies can expect to experience in additional costs if they price and hedge the contractual payments by using the hedging strategy derived in the recent lecture, whilst actually having to pay taxes from more realistic models. Our results show, based on a Vasicek short rate model, that the current Danish insurance accounting practice for taxes is, on average, on the safe side, however, with some additional capital required throughout the contract period and a value at risk of a few percent points of the initial value

Vejledere: Jesper Lund Pedersen,  Christian Furrer
Censor:     Jeppe Woetmann Nielsen, Edlund