Variational inequality arising from variable annuity with mean reversion environment

Abstract

In this paper, we study a variational inequality arising from variable annuity (VA) to find the optimal surrender strategy for a VA investor when the underlying asset follows a mean reverting process. We formulate the problem as a free boundary partial differential equation (PDE) to obtain the optimal strategy. The PDE is solved analytically by the Mellin transform approach. Using the Mellin transform, we derive the integral equations for the value of the VA and the optimal surrender boundary. Since the solutions are obtained as the integral equations, we use the recursive integration method to determine the optimal surrender strategy. Finally, we provide the optimal surrender boundaries and values of VA with respect to some significant parameters to show the impacts of mean reversion.

On the American style futures contracts

“…The form of the regions divides the American style derivatives into two types. The first one leads to a connected optimal set -usual options, [25,28], capped options, [5,29], power options, [20], variable annuities, [13]. This way we have a first hitting problem to a line.…”