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Valuation of insurers’ contingent capital with counterparty risk and price endogeneity

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  • Lo, Chien-Ling
  • Lee, Jin-Ping
  • Yu, Min-Teh

Abstract

This study develops a structural framework to value insurers’ contingent capital with counterparty risk (CR) and overcomes the problem of price endogeneity (PE) in the valuation model. Our results on the focal contingent capital instrument – catastrophe equity put option (CatEPut) – indicate that prices can be significantly overestimated without considering CR and be significantly underestimated without considering PE. This study also examines how CatEPuts affect the buyer’s probability of default (PD). Our results show that buying a CatEPut lowers the PD for high-risk insurers, but not necessarily so for low-risk insurers; however, without taking CR and PE into account, one may significantly overestimate the credit enhancement provided by the CatEPuts.

Suggested Citation

  • Lo, Chien-Ling & Lee, Jin-Ping & Yu, Min-Teh, 2013. "Valuation of insurers’ contingent capital with counterparty risk and price endogeneity," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5025-5035.
  • Handle: RePEc:eee:jbfina:v:37:y:2013:i:12:p:5025-5035
    DOI: 10.1016/j.jbankfin.2013.09.007
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    References listed on IDEAS

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    Cited by:

    1. repec:eee:reveco:v:55:y:2018:i:c:p:273-284 is not listed on IDEAS
    2. Krzysztof Burnecki & Mario Nicol'o Giuricich & Zbigniew Palmowski, 2018. "Valuation of contingent convertible catastrophe bonds - the case for equity conversion," Papers 1804.07997, arXiv.org.
    3. Chia-Chien Chang & Min-Teh Yu, 2017. "Valuing Vulnerable Mortgage Insurance Under Capital Forbearance," The Journal of Real Estate Finance and Economics, Springer, vol. 54(4), pages 558-578, May.
    4. repec:kap:jfsres:v:54:y:2018:i:1:d:10.1007_s10693-016-0259-9 is not listed on IDEAS
    5. Wang, Xingchun, 2016. "Catastrophe equity put options with target variance," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 79-86.

    More about this item

    Keywords

    Contingent capital; Catastrophe risk; Insurer’s default risk; Catastrophe equity puts; Contingent claim analysis;

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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