Valuing Catastrophe Derivatives Under Limited Diversification: A Stochastic Dominance Approach

35 Pages Posted: 1 Sep 2011 Last revised: 12 Sep 2011

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: August 19, 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 (August 19, 2011). Midwest Finance Association 2012 Annual Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1912549 or http://dx.doi.org/10.2139/ssrn.1912549

Stylianos Perrakis (Contact Author)

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

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

Ali Boloorforoosh

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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