Continuous Monitoring: Look Before You Leap

22 Pages Posted: 21 May 2008

See all articles by Snorre Lindset

Snorre Lindset

Norwegian University of Science and Technology (NTNU)

Svein-Arne Persson

Norwegian School of Economics (NHH)

Date Written: March 12, 2008

Abstract

We present a model for pricing credit risk protection for a limited liability non-life insurance company. The protection is typically provided by a guaranty fund. In the case of continuous monitoring, i.e., where the market values of the company's assets and liabilities are continuously observable, and where the market values of assets and liabilities follow continuous processes, the regulators can liquidate the insurance company at the instant the market value of its assets equals the market value of its liabilities, implying that the credit protection is worthless. When jumps are included in the claims process, the protection provided by the guaranty fund has a strictly positive market value. We argue that the ability to continuously monitor the equity value of a company can be a new explanation for why jump processes may be important in models of credit risk.

Keywords: credit risk for non-life insurers, guarantee fund, continuous monitoring, barrier options

JEL Classification: G13, G23, G33

Suggested Citation

Lindset, Snorre and Persson, Svein-Arne, Continuous Monitoring: Look Before You Leap (March 12, 2008). NHH Dept. of Finance & Management Science Discussion Paper No. 2008/8. Available at SSRN: https://ssrn.com/abstract=1135574 or http://dx.doi.org/10.2139/ssrn.1135574

Snorre Lindset

Norwegian University of Science and Technology (NTNU) ( email )

Trondheim NO-7491
Norway
+4773591395 (Phone)

Svein-Arne Persson (Contact Author)

Norwegian School of Economics (NHH) ( email )

Helleveien 30
Bergen, NO-5045
Norway
47-55-95-90-00 (Phone)
47-55-95-96-47 (Fax)

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