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DISCUSSION PAPER PI-0814

Modelling and Management of Mortality Risk: A Review

Andrew J.G. Cairns, David Blake and Kevin Dowd

In the first part of the paper, we consider the wide range of extrapolative stochastic
mortality models that have been proposed over the last 15-20 years. A number of
models that we consider are framed in discrete time and place emphasis on the
statistical aspects of modelling and forecasting. We discuss how these models can
be evaluated, compared and contrasted. We also discuss a discrete-time market
model that facilitates valuation of mortality-linked contracts with embedded options.
We then review several approaches to modelling mortality in continuous time. These
models tend to be simpler in nature, but make it possible to examine the potential for
dynamic hedging of mortality risk. Finally, we review a range of financial instruments
(traded and over-the-counter) that could be used to hedge mortality risk. Some of these,
such as mortality swaps, already exist, while others anticipate future developments in the market.

Keywords: Stochastic mortality models; Short-rate models; Market models; Cohort effect; SCOR
market model; Mortality-linked securities; Mortality swaps; q-forwards