Examples of various Research Projects conducted by academics within the Actuarial Studies and Business Analytics department.
The Impacts of a carbon-constrained world on the Financial Industry
Dr Lurion DeMello, Professor Stefan Trueck, joint project with Professor Marco Wilkens from University of Augsburg, funded by the Australia-Germany joint Research Co-operation Scheme
Carbon finance is a new research field in the area of environmental economics, energy markets and finance. Research in carbon finance focuses on the financial implications of living in a carbon-constrained world, where emissions of carbon dioxide and other greenhouse gases (GHG) carry a price. Investment funds and the financial industry as an important part of the overall economic system will be significantly affected by a more rigorous analysis of carbon footprints. This project examines the impacts of a carbon-constrained world on the financial industry, in particular investment behaviour with regards to carbon and energy intensive industries, performance measurement for individual stocks, bonds and funds in relationship to their carbon footprint. Applied research methods include factor models for asset pricing, econometric models for volatility and risk measurement and investor behaviour. The cooperation will provide new and vital research outcomes in this important new field that are relevant both to the Australian and German economy and their financial industry.
Dependence and spillover effects between regional Australian electricity markets
Miss Lin Han, Professor Stefan Trueck, joint project with the Capital Markets Collaborative Research Centre
Electricity markets are significantly more volatile than other comparable financial or commodity markets. This project examines the dependence between extreme events and volatility spillover effects across different regions in the Australian National Electricity Market (NEM).It aims to provide a better understanding of the transmission of risks in a multi-regional context. Our analysis is based on two different approaches: the econometric framework originally proposed by Diebold and Yilmaz (2012) and the extremogram (Davis et al., 2012) as a flexible quantitative tool for measuring various types of extremal dependence in a stationary time series. We conduct both a static and dynamic assessment of aggregated spillover effects as well as their directional decomposition between the individual regions. Our findings will provide important insights to market participants and regulators with regard to cross-regional trading of electricity, developing risk management strategies, and building additional interconnector infrastructure to facilitate regional market integration in the NEM.
Assessing basis risk for longevity transactions - Phase 2
Associate Professor Jackie Li
Continual improvement in mortality is a worldwide phenomenon. While it is certainly something to celebrate for human beings, it imposes a significant challenge to annuity providers and pension plan sponsors. Longevity risk is the risk that annuity portfolios or pension plans pay more than expected because of unanticipated mortality decline. This risk is composed of systematic longevity risk and non-systematic longevity risk. The latter risk can usually be reduced by increasing the portfolio size, but the former cannot be mitigated in the same way. In general, governments and financial institutions are very cautious about taking on too much longevity risk.
Besides traditional reinsurance, natural hedging, and insurance securitisation, there are recently many discussions in the UK on the feasibility of implementing index-based longevity hedging solutions. Considering the limited capacity of the insurance industry to absorb all the current exposures from the annuity markets and the pension plans, standardised index-based products have been proposed as a possible channel to draw interest from the investors in the wider capital market. From the hedger’s perspective, however, there is a major concern on the corresponding longevity basis risk, which arises from the potential mismatch between the hedging instrument and the portfolio being hedged. There are demographic or socioeconomic differences between the two underlying populations, randomness of individual lives, and differences in the payoff structures. In this project, funded by the Institute and Faculty of Actuaries (IFoA) and the Life and Longevity Markets Association (LLMA), our research team in Actuarial Studies and Business Analytics has performed an extensive analysis on the evaluation of this longevity basis risk and the effectiveness of index-based longevity hedging under practical circumstances. The project results have been presented in seminars organised by the IFoA, the Actuaries Institute, and a number of local and overseas universities.
More details of the longevity basis risk project can be found here.
The valuation of complex executive share options using black scholes exotic option pricing theory
Associate Professor Timothy Kyng
Multivariate Monte-Carlo Simulation and Economic Valuation of Complex Financial Contracts: An Excel Based Implementation
This paper covers the use of monte carlo simulation for valuation of a multi asset multi period type of ESO and its implementation in excel. This paper was published in the journal “spreadsheets in education” and since publication in 20015 it has had over 6000 downloads. Both academic institutions and financial institutions are downloading it. Excel is very widely used in the financial services industry for valuation of complex financial contracts. MC simulation is very commonly used by practitioners in the valuation of ESOs.
Valuation of employee stock options using the exercise multiple approach and life tables
This paper uses exotic option pricing theory to price ESOs allowing for voluntary early exercise driven by the stock price and involuntary early exercise driven by attrition during the exercise window. It uses dual expiry options and barrier options pricing theory to obtain an analytic valuation using the Hull White exercise multiple approach, along with a life table based numerical / analytic hybrid approach to handling of early exercise due to attrition. This semi analytic approach builds on the numerical approach proposed by Hull and White and avoids using the binomial / trinomial lattice and constant hazard rate assumption of Hull and White. This paper was published in the IME journal.
The actuarial analysis of retirement village contracts from a consumer perspective, and the development of an online retirement village cost comparison tool to assist consumers and their advisors with understanding and comparing different retirement village contracts
Associate Professor Timothy Kyng
I have written a working paper on the actuarial analysis of retirement village contracts from a consumer perspective. This paper is the result of several years of research work and the collection of data from consumers, retirement village managers and others, and analysis of contracts. We show that the RV contracts are very complex, there is a lot of variation in the contract design from village to village and even within villages and that the contracts have many insurance like features. The paper analyses the contract structure and shows that it is, from a financial perspective, a complex insurance – financial option hybrid contract. We derive various financial metrics to analyse the features of the contracts from a consumer perspective and to allow consumers to compare different rv contracts. The contracts are very opaque and complex and contain many risks for consumers. This paper is the theoretical basis for the Macquarie university online retirement village cost comparison calculator, which we obtained a grant of $128000 from financial literacy Australia to develop.