An intergenerational cross‐country swap

Abstract

Purpose

The purpose of this paper is to address the issue of intergenerational and international sharing of longevity and growth risks. Current research on worldwide demographic changes highlights the importance of longevity risk on financial markets and the need to devise optimal hedging vehicles.

Design/methodology/approach

The paper presents a potential financial innovation between two countries at different stages of economic development and with different long‐term challenges. This 30‐year‐long swap is structured in such a way to capture the different timing of needed funds of the two countries and the funding capabilities of each generation: the more developed economy requires funds in the future to cover expenses for its ageing population, while the developing economy needs funds today to pay for educational, technological, and other infrastructural services. To price the swap, the paper applies an exponential‐utility‐based pricing method and defines an interval of prices allowing a contract to be agreed upon.

Findings

Via the exponential‐utility‐based pricing method, the paper shows how the bid‐ask spread varies with respect to the governments' risk and time preferences.

Originality/value

The paper is believed to be the first to illustrate the structuring and pricing of a long‐term longevity swap between two countries at different stages of economic development and to discuss practical challenges derivative structures would face if they were to implement such a strategy.

Citation

Padovani, M. and Vanini, P. (2010), "An intergenerational cross‐country swap", Journal of Risk Finance, Vol. 11 No. 5, pp. 446-463. https://doi.org/10.1108/15265941011092040