Valuing Catastrophe Derivatives Under Limited Diversification: A Stochastic Dominance Approach

35 Pages Posted: 24 Jun 2011 Last revised: 20 Dec 2014

See all articles by Stylianos Perrakis

Stylianos Perrakis

Concordia University, Quebec - John Molson School of Business

Ali Boloorforoosh

Concordia University; TD Asset Management

Multiple version iconThere are 2 versions of this paper

Date Written: June 21, 2011

Abstract

We present a new approach to the pricing of catastrophe event derivatives that does not assume a fully diversifiable event risk. Instead, we assume that the event occurrence and intensity affect the return of the market portfolio of an agent that trades in the event derivatives. Based on this approach, we derive values for a CAT option and a reinsurance contract on an insurer’s assets using recent results from the option pricing literature. We show that the assumption of unsystematic event risk seriously underprices the CAT option. Last, we present numerical results for our derivatives using real data from hurricane landings in Florida.

Keywords: catastrophe events, jump processes, jump-diffusion, insurance products, derivative assets

JEL Classification: G13

Suggested Citation

Perrakis, Stylianos and Boloorforoosh, Ali, Valuing Catastrophe Derivatives Under Limited Diversification: A Stochastic Dominance Approach (June 21, 2011). Journal of Banking and Finance, Vol. 37, No. 8, 2013. Available at SSRN: https://ssrn.com/abstract=1869187 or http://dx.doi.org/10.2139/ssrn.1869187

Stylianos Perrakis

Concordia University, Quebec - John Molson School of Business ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1M8
Canada

Ali Boloorforoosh (Contact Author)

Concordia University ( email )

John Molson School of Business
1455 de Maisonnuve Blvd. W
Montreal, Quebec H3G 1M8
Canada
5142965877 (Phone)

HOME PAGE: http://aliboloor.com

TD Asset Management ( email )

1350 René-Lévesque Blvd W
Suite 501
Montreal, Quebec H3G 1T4
Canada
(514) 2890635 (Phone)

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