A Dynamic Factor Approach to Mortality Modeling

Longevity risk has become one of the major risks facing the insurance and pensions markets globally. The trade in longevity risk is underpinned by accurate forecasting of mortality rates. Using techniques from macroeconomic forecasting we propose a dynamic factor model of mortality that fits and forecasts age‐specific mortality rates parsimoniously. We compare the forecasting quality of this model against the Lee–Carter model and its variants. Our results show the dynamic factor model generally provides superior forecasts when applied to international mortality data. We also show that existing multifactorial models have superior fit but their forecasting performance worsens as more factors are added. The dynamic factor approach used here can potentially be further improved upon by applying an appropriate stopping rule for the number of static and dynamic factors. Copyright © 2013 John Wiley & Sons, Ltd.