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Catastrophic risks and the pricing of catastrophe equity put options

Author

Listed:
  • Massimo Arnone

    (University of Messina)

  • Michele Leonardo Bianchi

    (Bank of Italy)

  • Anna Grazia Quaranta

    (University of Macerata)

  • Gian Luca Tassinari

    (University of Bologna)

Abstract

In this paper, after a review of the most common financial strategies and products that insurance companies use to hedge catastrophic risks, we study an option pricing model based on processes with jumps where the catastrophic event is captured by a compound Poisson process with negative jumps. Given the importance that catastrophe equity put options (CatEPuts) have in this context, we introduce a pricing approach that provides not only a theoretical contribution whose applicability remains confined to purely numerical examples and experiments, but which can be implemented starting from real data and applied to the evaluation of real CatEPuts. We propose a calibration framework based on historical log-returns, market capitalization and option implied volatilities. The calibrated parameters are then considered to price CatEPuts written on the stock of the main Italian insurance company over the high volatile period from January to April 2020. We show that the ratio between plain-vanilla put options and CatEPuts strictly depends on the shape of the implied volatility smile and it varies over time.

Suggested Citation

  • Massimo Arnone & Michele Leonardo Bianchi & Anna Grazia Quaranta & Gian Luca Tassinari, 2021. "Catastrophic risks and the pricing of catastrophe equity put options," Computational Management Science, Springer, vol. 18(2), pages 213-237, June.
    • Handle: RePEc:spr:comgts:v:18:y:2021:i:2:d:10.1007_s10287-021-00391-y
    DOI: 10.1007/s10287-021-00391-y
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    References listed on IDEAS

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    Cited by:

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    2. Guillermo Sierra Juárez, 2023. "Prima para la cobertura por exceso de contagios de COVID-19," Remef - Revista Mexicana de Economía y Finanzas Nueva Época REMEF (The Mexican Journal of Economics and Finance), Instituto Mexicano de Ejecutivos de Finanzas, IMEF, vol. 18(2), pages 1-17, Abril - J.
    3. Keisuke Kizaki & Taiga Saito & Akihiko Takahashi, 2022. "A multi-agent incomplete equilibrium model and its applications to reinsurance pricing and life-cycle investment," CARF F-Series CARF-F-551, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo, revised Aug 2023.

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    More about this item

    Keywords

    Catastrophe equity put options; Variance gamma; Compound Poisson; Double-calibration;
    All these keywords.

    JEL classification:

    • C2 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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