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Value adjustments and dynamic hedging of reinsurance counterparty risk

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Listed:
  • Claudia Ceci
  • Katia Colaneri
  • Rdiger Frey
  • Verena Kock

Abstract

Reinsurance counterparty credit risk (RCCR) is the risk of a loss arising from the fact that a reinsurance company is unable to fulfill her contractual obligations towards the ceding insurer. RCCR is an important risk category for insurance companies which, so far, has been addressed mostly via qualitative approaches. In this paper we therefore study value adjustments and dynamic hedging for RCCR. We propose a novel model that accounts for contagion effects between the default of the reinsurer and the price of the reinsurance contract. We characterize the value adjustment in a reinsurance contract via a partial integro-differential equation (PIDE) and derive the hedging strategies using a quadratic method. The paper closes with a simulation study which shows that dynamic hedging strategies have the potential to significantly reduce RCCR.

Suggested Citation

  • Claudia Ceci & Katia Colaneri & Rdiger Frey & Verena Kock, 2019. "Value adjustments and dynamic hedging of reinsurance counterparty risk," Papers 1909.04354, arXiv.org.
    • Handle: RePEc:arx:papers:1909.04354
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    References listed on IDEAS

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    4. Vandaele, Nele & Vanmaele, Michèle, 2008. "A locally risk-minimizing hedging strategy for unit-linked life insurance contracts in a Lévy process financial market," Insurance: Mathematics and Economics, Elsevier, vol. 42(3), pages 1128-1137, June.
    5. Rüdiger Frey & Lars Rösler, 2014. "Contagion Effects And Collateralized Credit Value Adjustments For Credit Default Swaps," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 17(07), pages 1-29.
    6. Francesca Biagini & Camila Botero & Irene Schreiber, 2017. "Risk-Minimization For Life Insurance Liabilities With Dependent Mortality Risk," Mathematical Finance, Wiley Blackwell, vol. 27(2), pages 505-533, April.
    7. Ceci, Claudia & Colaneri, Katia & Cretarola, Alessandra, 2017. "Unit-linked life insurance policies: Optimal hedging in partially observable market models," Insurance: Mathematics and Economics, Elsevier, vol. 76(C), pages 149-163.
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