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Convergence Of Capital And Insurance Markets: Consistent Pricing Of Index‐Linked Catastrophe Loss Instruments

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  • Nadine Gatzert
  • Sebastian Pokutta
  • Nikolai Vogl

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.

Suggested Citation

  • Nadine Gatzert & Sebastian Pokutta & Nikolai Vogl, 2019. "Convergence Of Capital And Insurance Markets: Consistent Pricing Of Index‐Linked Catastrophe Loss Instruments," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 86(1), pages 39-72, March.
    • Handle: RePEc:bla:jrinsu:v:86:y:2019:i:1:p:39-72
    DOI: 10.1111/jori.12191
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    Cited by:

    1. Carolyn W. Chang & Jack S. K. Chang & Min‐Teh Yu & Yang Zhao, 2020. "Portfolio optimization in the catastrophe space," European Financial Management, European Financial Management Association, vol. 26(5), pages 1414-1448, November.
    2. Chang Carolyn W. & Feng Yalan, 2021. "Hurricane Bond Price Dependency on Underlying Hurricane Parameters," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 15(1), pages 1-21, January.
    3. Denuit, Michel & Ortega-Jimenez, Patricia & Robert, Christian Y., 2024. "Conditional expectations given the sum of independent random variables with regularly varying densities," LIDAM Discussion Papers ISBA 2024006, Université catholique de Louvain, Institute of Statistics, Biostatistics and Actuarial Sciences (ISBA).
    4. Peter Carayannopoulos & Olga Kanj & M. Fabricio Perez, 2022. "Pricing dynamics in the market for catastrophe bonds," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 47(1), pages 172-202, January.
    5. Liu, Haibo & Tang, Qihe & Yuan, Zhongyi, 2021. "Indifference pricing of insurance-linked securities in a multi-period model," European Journal of Operational Research, Elsevier, vol. 289(2), pages 793-805.
    6. Beer, Simone & Braun, Alexander, 2022. "Market-consistent valuation of natural catastrophe risk," Journal of Banking & Finance, Elsevier, vol. 134(C).

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