Financial Valuation of Mortality Risk via the Instantaneous Sharpe Ratio: Applications to Pricing Pure Endowments

We develop a theory for pricing non-diversifiable mortality risk in an incomplete market. We do this by assuming that the company issuing a mortality-contingent claim requires compensation for this risk in the form of a pre-specified instantaneous Sharpe ratio. We prove that our ensuing valuation formula satisfies a number of desirable properties. For example, we show that it is subadditive in the number of contracts sold. A key result is that if the hazard rate is stochastic, then the risk-adjusted survival probability is greater than the physical survival probability, even as the number of contracts approaches infinity.