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Evaluating catastrophe reinsurance contracts: an option pricing approach with extreme risk

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  • Wen-Chang Lin
  • Yi-Hsun Lai

Abstract

This study evaluates a government-sponsored Excess-Of-Loss (XOL) Catastrophe (CAT) reinsurance contract using the financial option approach with extreme risk. We show that the Generalized Pareto Distribution (GPD), a Peak-Over-Threshold (POT) model, can properly depict the extreme losses from natural disasters in Taiwan, and thus can produce the most moderate premium estimates compared to other tail distributions. We contend that the risk neutral pricing is applicable even if CAT is a systematic risk and the reinsurance market is incomplete. Lastly, the impact of choosing thresholds on premium estimates is also examined.

Suggested Citation

  • Wen-Chang Lin & Yi-Hsun Lai, 2012. "Evaluating catastrophe reinsurance contracts: an option pricing approach with extreme risk," Applied Financial Economics, Taylor & Francis Journals, vol. 22(12), pages 1017-1028, June.
    • Handle: RePEc:taf:apfiec:v:22:y:2012:i:12:p:1017-1028
    DOI: 10.1080/09603107.2011.636020
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    References listed on IDEAS

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    1. Vivek J. Bantwal & Howard C. Kunreuther, 1999. "A Cat Bond Premium Puzzle?," Center for Financial Institutions Working Papers 99-26, Wharton School Center for Financial Institutions, University of Pennsylvania.
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    Cited by:

    1. Hilda Azkiyah Surya & Herlina Napitupulu & Sukono, 2023. "Double Risk Catastrophe Reinsurance Premium Based on Houses Damaged and Deaths," Mathematics, MDPI, vol. 11(4), pages 1-18, February.
    2. Sarra Ghaddab & Manel Kacem & Christian Peretti & Lotfi Belkacem, 2023. "Extreme severity modeling using a GLM-GPD combination: application to an excess of loss reinsurance treaty," Empirical Economics, Springer, vol. 65(3), pages 1105-1127, September.

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