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How Does Financial Theory Apply to Catastrophe-Linked Derivatives? An Empirical Test of Several Pricing Models
Stockholm University, Faculty of Social Sciences, Stockholm Business School. Universidad Carlos III de Madrid, Spain.ORCID iD: 0000-0002-1097-3784
1999 (English)In: Journal of Risk and Insurance, ISSN 0022-4367, E-ISSN 1539-6975, Vol. 66, no 4, 551-581 p.Article in journal (Refereed) Published
Abstract [en]

This paper discusses the PCS Catastrophe Insurance Option Contracts, providing empirical support on the level of correspondence between real quotes and standard financial theory. The highest possible precision is incorporated since the real quotes are perfectly synchronized and the bid-ask spread is always considered. A static setting is assumed and the main topics of arbitrage, hedging, and portfolio choice are involved in the analysis. Three significant conclusions are reached. First, the catastrophe derivatives may often be priced by arbitrage methods, and the paper provides some examples of practical strategies that were available in the market. Second, hedging arguments also yield adequate criteria to price the derivatives, and some real examples are provided as well. Third, in a variance aversion context many agents could be interested in selling derivatives to invest the money in stocks and bonds. These strategies show a suitable level in the variance for any desired expected return. Furthermore, the methodology here applied seems to be quite general and may be useful to price other derivative securities. Simple assumptions on the underlying asset behavior are the only required conditions.

Place, publisher, year, edition, pages
1999. Vol. 66, no 4, 551-581 p.
National Category
Economics and Business
Identifiers
URN: urn:nbn:se:su:diva-121013DOI: 10.2307/253863OAI: oai:DiVA.org:su-121013DiVA: diva2:855614
Available from: 2015-09-21 Created: 2015-09-21 Last updated: 2017-12-04Bibliographically approved

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