IDEAS home Printed from https://ideas.repec.org/p/hhs/nhhfms/2008_008.html
   My bibliography  Save this paper

Continuous Monitoring: Look before You Leap

Author

Listed:

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.

Suggested Citation

  • 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
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/11250/163930
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Goldstein, Robert & Ju, Nengjiu & Leland, Hayne, 2001. "An EBIT-Based Model of Dynamic Capital Structure," The Journal of Business, University of Chicago Press, vol. 74(4), pages 483-512, October.
    2. repec:bla:jfinan:v:43:y:1988:i:4:p:823-39 is not listed on IDEAS
    3. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
    4. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
    5. Mark Broadie & Paul Glasserman & Steven Kou, 1997. "A Continuity Correction for Discrete Barrier Options," Mathematical Finance, Wiley Blackwell, vol. 7(4), pages 325-349, October.
    6. Lindset, Snorre & Persson, Svein-Arne, 2006. "A note on a barrier exchange option: The world's simplest option formula?," Finance Research Letters, Elsevier, vol. 3(3), pages 207-211, September.
    7. Fischer, Stanley, 1978. "Call Option Pricing when the Exercise Price Is Uncertain, and the Valuation of Index Bonds," Journal of Finance, American Finance Association, vol. 33(1), pages 169-176, March.
    8. Philippe Jorion, 1988. "On Jump Processes in the Foreign Exchange and Stock Markets," The Review of Financial Studies, Society for Financial Studies, vol. 1(4), pages 427-445.
    9. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-186, March.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    2. Wang, Guanying & Wang, Xingchun & Shao, Xinjian, 2022. "Exchange options for catastrophe risk management," The North American Journal of Economics and Finance, Elsevier, vol. 59(C).
    3. Hu, May & Park, Jason, 2019. "Valuation of collateralized debt obligations: An equilibrium model," Economic Modelling, Elsevier, vol. 82(C), pages 119-135.
    4. Minqiang Li & Kyuseok Lee, 2011. "An adaptive successive over-relaxation method for computing the Black-Scholes implied volatility," Quantitative Finance, Taylor & Francis Journals, vol. 11(8), pages 1245-1269.
    5. Jin, Ting & Ding, Hui & Xia, Hongxuan & Bao, Jinfeng, 2021. "Reliability index and Asian barrier option pricing formulas of the uncertain fractional first-hitting time model with Caputo type," Chaos, Solitons & Fractals, Elsevier, vol. 142(C).
    6. Lloyd Blenman & Steven Clark, 2005. "Options with Constant Underlying Elasticity in Strikes," Review of Derivatives Research, Springer, vol. 8(2), pages 67-83, August.
    7. Mondher Bellalah, 2009. "Derivatives, Risk Management & Value," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 7175, August.
    8. Liming Feng & Vadim Linetsky, 2008. "Pricing Discretely Monitored Barrier Options And Defaultable Bonds In Lévy Process Models: A Fast Hilbert Transform Approach," Mathematical Finance, Wiley Blackwell, vol. 18(3), pages 337-384, July.
    9. Munk, Claus, 2015. "Financial Asset Pricing Theory," OUP Catalogue, Oxford University Press, number 9780198716457.
    10. Lindset, Snorre & Persson, Svein-Arne, 2006. "A note on a barrier exchange option: The world's simplest option formula?," Finance Research Letters, Elsevier, vol. 3(3), pages 207-211, September.
    11. Wang, Xingchun, 2020. "Pricing options on the maximum or minimum of multi-assets under jump-diffusion processes," International Review of Economics & Finance, Elsevier, vol. 70(C), pages 16-26.
    12. Zhou, Chunsheng, 2001. "The term structure of credit spreads with jump risk," Journal of Banking & Finance, Elsevier, vol. 25(11), pages 2015-2040, November.
    13. Suresh M. Sundaresan, 2000. "Continuous‐Time Methods in Finance: A Review and an Assessment," Journal of Finance, American Finance Association, vol. 55(4), pages 1569-1622, August.
    14. Stephan Dieckmann & Michael Gallmeyer, 2006. "Pricing Rare Event Risk in Emerging Markets," 2006 Meeting Papers 305, Society for Economic Dynamics.
    15. Olivier Courtois & Xiaoshan Su, 2020. "Structural Pricing of CoCos and Deposit Insurance with Regime Switching and Jumps," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 27(4), pages 477-520, December.
    16. Gatzert, Nadine & Schmeiser, Hato, 2008. "The influence of corporate taxes on pricing and capital structure in property-liability insurance," Insurance: Mathematics and Economics, Elsevier, vol. 42(1), pages 50-58, February.
    17. Wang, Xingchun, 2016. "Pricing power exchange options with correlated jump risk," Finance Research Letters, Elsevier, vol. 19(C), pages 90-97.
    18. Liu, Yu-hong & Jiang, I-Ming & Hsu, Wei-tze, 2018. "Compound option pricing under a double exponential Jump-diffusion model," The North American Journal of Economics and Finance, Elsevier, vol. 43(C), pages 30-53.
    19. Sanjay K. Nawalkha & Xiaoyang Zhuo, 2022. "A Theory of Equivalent Expectation Measures for Contingent Claim Returns," Journal of Finance, American Finance Association, vol. 77(5), pages 2853-2906, October.
    20. Mark Broadie & Jerome B. Detemple, 2004. "ANNIVERSARY ARTICLE: Option Pricing: Valuation Models and Applications," Management Science, INFORMS, vol. 50(9), pages 1145-1177, September.

    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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hhs:nhhfms:2008_008. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Stein Fossen (email available below). General contact details of provider: https://edirc.repec.org/data/dfnhhno.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.