Partial Hedging of Spread Options with a Given Probability

The paper develops the method of hedging a two-factor diffusion market with a given probability. We construct the maximal perfect hedging set for an option to exchange for another for which a lower bound of option price is achieved. This method is then applied to pricing “pure endowments with a guarantee” equity linked life insurance contracts. The classical approach of pricing such options provides very low gain for investors, the investor may take a given probability of risk in return of a higher gain. Taken into account this argument, the paper develops risk management strategies for this type of insurance and financial mixed instrument.