Valuation of guaranteed annuity conversion options

In this note we introduce a theoretical model for the pricing and valuation of guaranteed annuity conversion options associated with certain deferred annuity pension-type contracts in the UK. The valuation approach is based on the similarity between the payoff structure of the contract and a call option written on a coupon-bearing bond. The model makes use of a one-factor Heath–Jarrow–Morton framework for the term structure of interest rates. Numerical results are investigated and the sensitivity of the price of the option to changes in the key parameters is also analyzed.