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IAI Actuarial Core Principles · Economic Modelling · Valuing benefit guarantees using simulation

An insurer has hedged a guarantee with delta hedging and wants to reduce the residual risk from changes in the volatility assumption. Which Greek measures the sensitivity of the guarantee's value to changes in volatility?

Vega measures the sensitivity of the guarantee's value to changes in volatility. Delta relates to the asset price, gamma to the change in delta, theta to time passing and rho to interest rates. Delta hedging leaves vega exposure unhedged.

  1. ADelta
  2. BGamma
  3. CTheta
  4. DVegaCorrect
  5. Rho

Explanation

Vega is the partial derivative of the option value with respect to volatility. Delta measures sensitivity to the underlying price, gamma to the change in delta, theta to time, and rho to the interest rate. Delta hedging does not remove vega exposure, so separate instruments are needed.

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