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The Economics of Insurance: A Derivatives-Based Approach

Author

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  • Robert A. Jarrow

    (S.C. Johnson Graduate School of Management, Cornell University, Ithaca, New York 14853, USA)

Abstract

This article revisits the economics of insurance using insights from derivatives pricing and hedging. Applying this perspective, I emphasize the following insights applicable to insurance. First, I provide a valid justification for the use of arbitrage-free insurance premiums. This justification applies in both complete and incomplete markets. Second, I demonstrate the importance of diversifiable idiosyncratic risk for the determination of insurance premiums. And third, analyzing the insurance industry using the functional approach, I show the importance of derivatives and the synthetic construction of derivatives for reducing an insurance company's insolvency risk.

Suggested Citation

  • Robert A. Jarrow, 2021. "The Economics of Insurance: A Derivatives-Based Approach," Annual Review of Financial Economics, Annual Reviews, vol. 13(1), pages 79-110, November.
    • Handle: RePEc:anr:refeco:v:13:y:2021:p:79-110
    DOI: 10.1146/annurev-financial-040721-075128
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    Cited by:

    1. Robert A. Jarrow, 2023. "The no-arbitrage pricing of non-traded assets," Annals of Finance, Springer, vol. 19(3), pages 401-418, September.

    More about this item

    Keywords

    insurance; derivatives; insolvency; probability of ruin; insurance premiums; risk-neutral valuation; diversifiable risk;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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