We propose an optimization criterion that yields extraordinary consumption smoothing compared to the well known results of the life-cycle model. Under this criterion we solve the related consumption and investment optimization problem faced by individuals with preferences for intertemporal stability in consumption. We find that the consumption and investment patterns demanded under the optimization criterion is in general offered as annuity benefits from products in the class of ‘Formula Based Smoothed Investment-Linked Annuities’.

Abstract This paper provides a unifying framework for the modeling of various types of credit risks such as contagion effects. We argue that Markov chains can efficiently be used to tackle these problems. However, our approach is not limited to pricing problems with contagion. On the theoretical side, we derive pricing formulas for three building blocks that are generalizations of contingent claims studied in Lando (1998). These claims can be thought of as atoms forming the basis for all credit risk payments. Furthermore, we demonstrate that, in general, all contingent claims exposed to credit risk satisfy a system of partial differential equations. This is the key result to calculate prices of credit risk claims explicitly and efficiently.