Advanced Search
MyIDEAS: Login to save this paper or follow this series

The Pricing of Event Risks with Parameter Uncertainty

Contents:

Author Info

  • Kenneth A. Froot
  • Steven E. Posner

Abstract

Financial instruments whose payoffs are linked to exogenous events, such as the occurrence of a natural catastrophe or an unusual weather pattern depend crucially on actuarial models for determining event (e.g., default) probabilities. In many instances, investors appear to receive premiums far in excess of these modeled actuarial probabilities, even for event risks that are uncorrelated with returns on other financial assets. Some have attributed these larger spreads to uncertainty in the probabilities generated by the models. We provide a simple model of such 'parameter uncertainty' and demonstrate how it affects rational investors' demand for event risk exposures. We show that while parameter uncertainty does indeed affect bond spreads, it does not tend to increase spreads by much. Indeed, the spread increases due to parameter uncertainty in our numerical examples are on the order of only 1-2 basis points. Moreover, in many instances, including those that have the most sensible correlation settings, parameter uncertainty tends to decrease the size of bond spreads. We therefore argue that parameter uncertainty does not appear to be a satisfactory explanation for high event-risk returns.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.nber.org/papers/w8106.pdf
Download Restriction: no

Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8106.

as in new window
Length:
Date of creation: Feb 2001
Date of revision:
Publication status: published as Kenneth A. Froot & Steven E. Posner, 2002. "The Pricing of Event Risks with Parameter Uncertainty," The Geneva Risk and Insurance Review, Palgrave Macmillan, vol. 27(2), pages 153-165, December.
Handle: RePEc:nbr:nberwo:8106

Note: AP CF
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Email:
Web page: http://www.nber.org
More information through EDIRC

Related research

Keywords:

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

No references listed on IDEAS
You can help add them by filling out this form.

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Turvey, Calum G. & Weersink, Alfons, 2005. "Pricing Weather Insurance with a Random Strike Price: An Application to the Ontario Ice Wine Harvest," 2005 Annual meeting, July 24-27, Providence, RI, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association) 19255, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  2. Yiqun Mou & Lars A. Lochstoer & Michael Johannes, 2011. "Learning about Consumption Dynamics," 2011 Meeting Papers 306, Society for Economic Dynamics.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:8106. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

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 references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

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