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Learning about Risk: Some Lessons from Insurance

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  • Hélyette Geman

Abstract

This paper argues that in the fundamental subject of financial risk analysis, some valuable lessons may be drawn from insurance. The probability of ruin, defined as a first passage time, carries a dynamic element whose absence in Value at Risk is one liability, among others. Extreme value theory, which has been successfully applied to insurance shortly after it was introduced in probability, may offer a coherent framework for analyzing the extreme moves such as the ones observed in recent foreign exchange and financial crises. Lastly, we show that the genuine hazards generated by global capital markets and illustrated by the events of summer 1998, generate a market incompleteness that existing models of defaultable bonds do not fully address. In contrast, the long experience of risk premium analysis in the insurance and reinsurance industry, as well as the existence of historical data on natural disasters, render the valuation of catastrophe bonds less perilous than that of defaultable bonds.

Suggested Citation

  • Hélyette Geman, 1999. "Learning about Risk: Some Lessons from Insurance," Review of Finance, European Finance Association, vol. 2(2), pages 113-124.
    • Handle: RePEc:oup:revfin:v:2:y:1999:i:2:p:113-124.
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    File URL: http://hdl.handle.net/10.1023/A:1009835429630
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    Cited by:

    1. Beer, Simone & Braun, Alexander, 2022. "Market-consistent valuation of natural catastrophe risk," Journal of Banking & Finance, Elsevier, vol. 134(C).
    2. Becherer, Dirk, 2003. "Rational hedging and valuation of integrated risks under constant absolute risk aversion," Insurance: Mathematics and Economics, Elsevier, vol. 33(1), pages 1-28, August.
    3. Harris, Richard D.F. & Nguyen, Linh H. & Stoja, Evarist, 2019. "Systematic extreme downside risk," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 61(C), pages 128-142.
    4. Denuit Michel & Dhaene Jan & Goovaerts Marc & Kaas Rob & Laeven Roger, 2006. "Risk measurement with equivalent utility principles," Statistics & Risk Modeling, De Gruyter, vol. 24(1), pages 1-25, July.

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