The default free short term interest rate is one of the most commonly researched economic variables. It directly influences the short end of the term structure and, thus, has implications for valuing fixed income securities and derivatives. Furthermore, it is a general reference point for asset pricing on the basis that expected equilibrium returns on risky assets are expressed in terms of excess returns relative to the risk free rate.
Global current account imbalances and the net capital flows they entail have been at the forefront of policy debates in recent years. In the wake of the financial crisis, many observers and policymakers have singled them out as a key factor contributing to the turmoil. A prominent view is that an excess of saving over investment in emerging market countries, as reflected in corresponding current account surpluses, eased financial conditions in deficit countries and exerted significant downward pressure on world interest rates. In so doing, this flow of saving helped to fuel a credit boom and risk-taking in major advanced economies, particularly in the United States, thereby sowing the seeds of the global financial crisis.
The market for longevity-linked securities and derivatives has recently experienced a surge in transactions in longevity swaps. These are agreements between two parties to exchange fixed payments against variable payments linked to the number of survivors in a reference population (see Dowd et al., 2006). Table 1 presents a list of recent deals that have been publicly disclosed. So far, transactions have mainly involved pension funds and annuity providers wanting to hedge their exposure to longevity risk but with out having to bear any basis risk: the variable payments in such longevity swaps are designed to match precisely the mortality experience of each individual hedger (hence the name indemnity-based, or bespoke, longevity swaps).
