On Life Settlement Pricing

Although life settlements as financial products have been in existence and ac-tive use in financial markets for quite some time, their pricing has never reached the level of transparency and standardization envisioned by Wall Street. This lack of standardization has been and still is the major roadblock against wide-spread use of life settlements as investment, diversication and portfolio risk management tools. However, the recent crisis of 2007 has revealed high levels of correlation among existing financial instruments that are in widespread use. This revelation raised an avid interest in new financial instruments that show low correlation to strong market swings. In this respect, life settlements and re-lated products such as death bonds have gained popularity among practitioners and academics alike. This paper proposes a standard pricing framework for life settlements that is consistent with existing methods of risk management and sensitivity analysis widely used in fixed income products. 1 Bilkan Erkmen is a senior in the Economics Department at Princeton University and he is pursuing minors in nance and applied & computational mathematics. His research interests lie in the application of financial mathematics and computational methods to asset pricing problems. The author wishes to extend his warmest thanks to Yuliy Sannikov for his insightful comments and terrific guidance throughout the research process. THE MICHIGAN JOURNAL OF BUSINESS72 I