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Wanting robustness in insurance: A model of catastrophe risk pricing and its empirical test

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  • Zhu, Wenge

Abstract

Motivated by the fact that a lack of information about natural disasters may lead agents to be ambiguity averse to catastrophe risks, we introduce a new type of penalty function and propose an adjusted equilibrium model based on the function by allowing agents to act in a robust control framework against model misspecification with respect to rare events. The pricing formulas are then derived for various catastrophe linked securities such as catastrophe futures, options and bonds. We also estimate and test the model using empirical data of catastrophe bonds and compare it with various other models and investigate the robustness performance of alternative pricing formulas.

Suggested Citation

  • Zhu, Wenge, 2017. "Wanting robustness in insurance: A model of catastrophe risk pricing and its empirical test," Insurance: Mathematics and Economics, Elsevier, vol. 77(C), pages 14-23.
    • Handle: RePEc:eee:insuma:v:77:y:2017:i:c:p:14-23
    DOI: 10.1016/j.insmatheco.2017.08.006
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    References listed on IDEAS

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    Cited by:

    1. Wu, Yang-Che, 2020. "Equilibrium in natural catastrophe insurance market under disaster-resistant technologies, financial innovations and government interventions," Insurance: Mathematics and Economics, Elsevier, vol. 95(C), pages 116-128.
    2. Chen, Yiqing & White, Toby & Yuen, Kam Chuen, 2021. "Precise large deviations of aggregate claims with arbitrary dependence between claim sizes and waiting times," Insurance: Mathematics and Economics, Elsevier, vol. 97(C), pages 1-6.

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    More about this item

    Keywords

    Ambiguity aversion; Robust control theory; Catastrophe risk pricing; CAT bonds; Catastrophe-linked securities;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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