Pricing annuity guarantees under a double regime-switching model

This paper is concerned with the valuation of equity-linked annuities with mortality risk under a double regime-switching model, which provides a way to endogenously determine the regime-switching risk. The model parameters and the reference investment fund price level are modulated by a continuous-time, finite-time, observable Markov chain. In particular, the risk-free interest rate, the appreciation rate, the volatility and the martingale describing the jump component of the reference investment fund are related to the modulating Markov chain. Two approaches, namely, the regime-switching Esscher transform and the minimal martingale measure, are used to select pricing kernels for the fair valuation. Analytical pricing formulas for the embedded options underlying these products are derived using the inverse Fourier transform. The fast Fourier transform approach is then used to numerically evaluate the embedded options. Numerical examples are provided to illustrate our approach.