Catastrophe Futures and Reinsurance Contracts: An Incomplete Markets Approach

Abstract

We present a theoretical methodology based on stochastic dominance for the pricing of catastrophe (CAT) derivatives with non-convex payoffs given the price of a CAT indexed futures contract. We do not assume a fully diversifiable CAT event risk, nor do we assume knowledge of the martingale probability measure beyond the futures price. We derive tight bounds on the contract value and present trading strategies exploiting the mispricing whenever the value lies outside the bounds. We estimate numerically the bounds of the reinsurance contract with real data from hurricane landings in Florida.