Designing minimum guaranteed return funds

Abstract

In recent years there has been a significant growth of investment products aimed at attracting investors who are worried about the downside potential of the financial markets. This paper introduces a dynamic stochastic optimization model for the design of such products. The pricing of minimum guarantees as well as the valuation of a portfolio of bonds based on a three-factor term structure model are described in detail. This allows us to accurately price individual bonds, including the zero-coupon bonds used to provide risk management, rather than having to rely on a generalized bond index model.

Keywords:

• Dynamic stochastic programming
• Asset & liability management
• Guaranteed returns
• Yield curve
• Economic factor model

Acknowledgments

The authors wish to thank Drs. Yee Sook Yong and Ning Zhang for their able assistance with computational matters. We also acknowledge the helpful comments of two anonymous referees which led to material improvements in the paper.