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Basis risk management and randomly scaled uncertainty

Author

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  • Mercè Claramunt, M.
  • Lefèvre, Claude
  • Loisel, Stéphane
  • Montesinos, Pierre

Abstract

This paper proposes a method for quantifying the basis risk present in index-based insurance. It applies when the inherent uncertainty is represented by a randomly scaled variable. This turns out to be a reasonable assumption in a number of practical situations. Several properties of such a variable are first briefly studied. Their order in the s-convex sense is discussed and the associated extreme distributions are obtained to generate the worst situations. In each scenario, the basis risk consequences are then assessed using a penalty function that takes into account the risk tolerances of the protection buyer. Basis risk limits for a fixed budget can also be set. The proposed approach is illustrated by a few simple examples.

Suggested Citation

  • Mercè Claramunt, M. & Lefèvre, Claude & Loisel, Stéphane & Montesinos, Pierre, 2022. "Basis risk management and randomly scaled uncertainty," Insurance: Mathematics and Economics, Elsevier, vol. 107(C), pages 123-139.
    • Handle: RePEc:eee:insuma:v:107:y:2022:i:c:p:123-139
    DOI: 10.1016/j.insmatheco.2022.08.005
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    References listed on IDEAS

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    More about this item

    Keywords

    Basis risk; Index-based insurance; Randomly scaled variables; s-convex orders; Penalty functions;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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