PRICING SURVIVOR DERIVATIVES WITH COHORT MORTALITY DEPENDENCE UNDER THE LEE-CARTER FRAMEWORK

Abstract

This article introduces cohort mortality dependence in mortality modeling. We extend the classical Lee-Carter model to incorporate cohort mortality de-pendence by considering mortality correlations for a cohort of people born in the same year. The pattern of cohort mortality dependence is demonstrated on the basis of U.S. mortality experience. We study the effect of cohort mor-tality dependence on the pricing of survivor derivatives. For this purpose, a survivor floor is introduced. To understand the difference between a sur-vivor floor and other survivor securities, the valuation formulas for survivor swaps and survivor floors are all derived in detail and the effects of co-hort mortality dependence on pricing survivor derivatives are investigated numerically.