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Continuous Monitoring: Look before You Leap

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Abstract

We present a model for pricing credit risk protection for a limited liability non-life insurance company. The protection is typically provided by a guaranty fund. In the case of continuous monitoring, i.e., where the market values of the company's assets and liabilities are continuously observable, and where the market values of assets and liabilities follow continuous processes, the regulators can liquidate the insurance company at the instant the market value of its assets equals the market value of its liabilities, implying that the credit protection is worthless. When jumps are included in the claims process, the protection provided by the guaranty fund has a strictly positive market value. We argue that the ability to continuously monitor the equity value of a company can be a new explanation for why jump processes may be important in models of credit risk.

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  • Lindset, Snorre & Persson, Svein-Arne, 2008. "Continuous Monitoring: Look before You Leap," Discussion Papers 2008/8, Norwegian School of Economics, Department of Business and Management Science.
    • Handle: RePEc:hhs:nhhfms:2008_008
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    File URL: http://hdl.handle.net/11250/163930
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    More about this item

    Keywords

    Credit risk for non-life insurers; guarantee fund; continuous monitoring; barrier options;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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