Hedging Multi-Period Guarantees in the Presence of Transaction Costs via Stochastic Programming

Multi-period guarantees are often embedded in life insurance contracts. For the multi-period guarantee there is a rather large rebalancing of the hedge portfolio as we go from one period to the next. By introducing transaction costs, the size of this rebalancing is reduced. Transaction costs may therefore be one possible explanation for why we do not see the insurance companies performing a large rebalancing of their investment portfolio at the end of each year.