Hedging Catastrophe Risk Using Index-Based Reinsurance Instruments
نویسنده
چکیده
Index-based hedging instruments such as industry loss warranties are increasingly recognized as effective hedging tools for insurance and reinsurance portfolios. However, wider adoption of these instruments is inhibited by basis risk, the difference between the index-based payoff and the buyer's actual loss. This study presents a systematic approach for potential buyers to analyze and manage basis risk in order to take full advantage of the benefits offered by these instruments. We examine two measures of basis risk: (i) hedging effectiveness and (ii) conditional payoff shortfall. Many existing measures such as hedge volatility and correlation are special cases of the hedging effectiveness measure. Next, we study the tradeoffbetween basis risk and the cost of hedging. Finally, we present a robust numerical algorithm designed to optimize an index-based hedging program consisting of multiple index-based contracts.
منابع مشابه
Securitizing peanut production risk with catastrophe ( CAT ) bonds
--A catastrophe (CAT) bond is designed for peanut production as a means of transferring natural disaster risks from insurance purveyors to the global capital market. The CAT bond so designed is priced using state-level historical yields for peanut production in the southern part of the United States in the State of Georgia. The index triggering the CAT bond contract was based on percent deviati...
متن کاملAn Integrated Approach to Pricing Catastrophe Reinsurance
We propose an integrated approach straddling the actuarial science and the mathematical finance approaches to pricing a default-risky catastrophe reinsurance contract. We first apply an incomplete-market version of the no-arbitrage martingale pricing paradigm to price the reinsurance contract as a martingale by a measure change, then we apply risk loading to price in—as in the traditional actua...
متن کاملImproving Risk Allocation Through Cat Bonds
Catastrophe bonds (cat bonds) often use index triggers, such as, for instance, parametric descriptions of a catastrophe. This implies the problem of the so-called basis risk, resulting from the fact that, in contrast to traditional reinsurance, this kind of coverage cannot be a perfect hedge for the primary’s insured portfolio. On the other hand, cat bonds offer some very attractive economic fe...
متن کاملEfficient Optimization of Reinsurance Contracts using Discretized PBIL
Risk hedging strategies are at the heart of financial risk management. As with many financial institutions, insurance companies try to hedge their risk against potentially large losses, such as those associated with natural catastrophes. Much of this hedging is facilitated by engaging in risk transfer contracts with the global reinsurance market. Devising an effective hedging strategy depends o...
متن کاملBasis Risk with PCS Catastrophe Insurance Derivative Contracts
This study provides evidence of the potential hedging effectiveness of insurance derivatives based on regional estimates of catastrophe losses. We estimate the percentage of insurers’ by line and state underwriting risk that could have been eliminated over the 1974 through 1994 period if they had hedged using state-specific catastrophe derivatives based on Property Claims Service (PCS) reported...
متن کامل