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Pricing perpetual American CatEPut options when stock prices are correlated with catastrophe losses

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  • Kim, Hwa-Sung
  • Kim, Bara
  • Kim, Jerim

Abstract

A catastrophe equity put (CatEPut) option is a catastrophe derivative that allows insurance companies to raise equity capital when they face catastrophe losses. This study focuses on a pricing model for a CatEPut options. First, unlike previous research, this study provides a CatEPut option pricing model in which stock prices and catastrophe losses are moderately correlated. Second, this study examines the practical characteristics of American CatEPut options. Third, through a numerical analysis, we observe that it is necessary to consider the effects of a moderate correlation between stock prices and catastrophe losses on the prices of perpetual American CatEPut options.

Suggested Citation

  • Kim, Hwa-Sung & Kim, Bara & Kim, Jerim, 2014. "Pricing perpetual American CatEPut options when stock prices are correlated with catastrophe losses," Economic Modelling, Elsevier, vol. 41(C), pages 15-22.
    • Handle: RePEc:eee:ecmode:v:41:y:2014:i:c:p:15-22
    DOI: 10.1016/j.econmod.2014.04.007
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    References listed on IDEAS

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    1. Chia‐Chien Chang & Shih‐Kuei Lin & Min‐Teh Yu, 2011. "Valuation of Catastrophe Equity Puts With Markov‐Modulated Poisson Processes," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 78(2), pages 447-473, June.
    2. Jaimungal, Sebastian & Wang, Tao, 2006. "Catastrophe options with stochastic interest rates and compound Poisson losses," Insurance: Mathematics and Economics, Elsevier, vol. 38(3), pages 469-483, June.
    3. Chang, Lung-fu & Hung, Mao-wei, 2009. "Analytical valuation of catastrophe equity options with negative exponential jumps," Insurance: Mathematics and Economics, Elsevier, vol. 44(1), pages 59-69, February.
    4. Bakshi, Gurdip & Madan, Dilip, 2002. "Average Rate Claims with Emphasis on Catastrophe Loss Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(1), pages 93-115, March.
    5. Kim, Bara & Kim, Jeongsim, 2011. "Representation of Downton’s bivariate exponential random vector and its applications," Statistics & Probability Letters, Elsevier, vol. 81(12), pages 1743-1750.
    6. Gerber, Hans U. & Landry, Bruno, 1998. "On the discounted penalty at ruin in a jump-diffusion and the perpetual put option," Insurance: Mathematics and Economics, Elsevier, vol. 22(3), pages 263-276, July.
    7. Lin, Shih-Kuei & Chang, Chia-Chien & Powers, Michael R., 2009. "The valuation of contingent capital with catastrophe risks," Insurance: Mathematics and Economics, Elsevier, vol. 45(1), pages 65-73, August.
    8. Lin, X. Sheldon & Wang, Tao, 2009. "Pricing perpetual American catastrophe put options: A penalty function approach," Insurance: Mathematics and Economics, Elsevier, vol. 44(2), pages 287-295, April.
    9. Cox, Samuel H. & Fairchild, Joseph R. & Pedersen, Hal W., 2004. "Valuation of structured risk management products," Insurance: Mathematics and Economics, Elsevier, vol. 34(2), pages 259-272, April.
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    Cited by:

    1. Bi, Hongwei & Wang, Guanying & Wang, Xingchun, 2019. "Valuation of catastrophe equity put options with correlated default risk and jump risk," Finance Research Letters, Elsevier, vol. 29(C), pages 323-329.

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