Convergence of Capital and Insurance Markets Consistent Pricing of Index-Linked Catastrophic Loss Instruments
Journal
The Journal of Risk and Insurance
ISSN
0022-4367
Type
journal article
Date Issued
2017
Author(s)
Abstract
Index-linked catastrophe loss instruments have become increasingly
attractive for investors and play an important role in risk management.
Their payout is tied to the development of an underlying industry loss index
(reflecting losses from natural catastrophes) and may additionally depend
on the ceding company’s loss. Depending on the instrument, pricing is
currently not entirely transparent and does not assume a liquid market. We
show how arbitrage-free and market-consistent prices for such instruments
can be derived by overcoming the crucial point of tradability of the
underlying processes. We develop suitable approximation and replication
techniques and—based on these—provide explicit pricing formulas using
cat bond prices. Finally, we use empirical examples to illustrate the
suggested approximations.
attractive for investors and play an important role in risk management.
Their payout is tied to the development of an underlying industry loss index
(reflecting losses from natural catastrophes) and may additionally depend
on the ceding company’s loss. Depending on the instrument, pricing is
currently not entirely transparent and does not assume a liquid market. We
show how arbitrage-free and market-consistent prices for such instruments
can be derived by overcoming the crucial point of tradability of the
underlying processes. We develop suitable approximation and replication
techniques and—based on these—provide explicit pricing formulas using
cat bond prices. Finally, we use empirical examples to illustrate the
suggested approximations.
Language
English
HSG Classification
contribution to scientific community
Refereed
Yes
Publisher
Blackwell Publishing
Pages
34
Subject(s)
Division(s)
Eprints ID
255448