Valuation of Equity Linked Securities with Guaranteed Return

TL;DR

This paper introduces a new model for valuing equity-linked securities with guaranteed returns, using Asian options to accurately price these instruments and hedge risks effectively.

Contribution

A novel valuation model that represents equity-linked securities with guarantees as a combination of guaranteed amounts and Asian options, with analytical formulas and practical applications.

Findings

Model accurately prices securities across various parameters

Analytical formulas for security price and hedge ratios derived

Effective valuation of guaranteed segregated funds

Abstract

Equity-linked securities with a guaranteed return become very popular in financial markets ether as investment instruments or life insurance policies. The contract pays off a guaranteed amount plus a payment linked to the performance of a basket of equities averaged over a certain period. This paper presents a new model for valuing equity-linked securities. Our study shows that the security price can be replicated by the sum of the guaranteed amount plus the price of an Asian style option on the basket. Analytical formulas are derived for the security price and corresponding hedge ratios. The model appears to be accurate over a wide range of underlying security parameters according to numerical studies. Finally, we use our model to value a segregated fund with a guarantee at maturity.