Convergence of Capital and Insurance Markets: Consistent Pricing of Index‐Linked Catastrophe Loss Instruments

34 Pages Posted: 12 Feb 2019

See all articles by Nadine Gatzert

Nadine Gatzert

Friedrich-Alexander University Erlangen-Nürnberg

Sebastian Pokutta

Georgia Institute of Technology

Nikolai Vogl

Friedrich-Alexander University Erlangen-Nürnberg

Date Written: March 2019

Abstract

Index‐linked catastrophe loss instruments have become increasingly attractive for investors and play an important role in risk management. Their payout is tied to the development of an underlying industry loss index (reflecting losses from natural catastrophes) and may additionally depend on the ceding company's loss. Depending on the instrument, pricing is currently not entirely transparent and does not assume a liquid market. We show how arbitrage‐free and market‐consistent prices for such instruments can be derived by overcoming the crucial point of tradability of the underlying processes. We develop suitable approximation and replication techniques and—based on these—provide explicit pricing formulas using cat bond prices. Finally, we use empirical examples to illustrate the suggested approximations.

Suggested Citation

Gatzert, Nadine and Pokutta, Sebastian and Vogl, Nikolai, Convergence of Capital and Insurance Markets: Consistent Pricing of Index‐Linked Catastrophe Loss Instruments (March 2019). Journal of Risk and Insurance, Vol. 86, Issue 1, pp. 39-72, 2019. Available at SSRN: https://ssrn.com/abstract=3332578 or http://dx.doi.org/10.1111/jori.12191

Nadine Gatzert (Contact Author)

Friedrich-Alexander University Erlangen-Nürnberg ( email )

Lange Gasse 20
Nuremberg, 90403
Germany
+499115302884 (Phone)
+499115302888 (Fax)

HOME PAGE: http://www.vwrm.rw.fau.de

Sebastian Pokutta

Georgia Institute of Technology ( email )

Atlanta, GA 30332
United States

Nikolai Vogl

Friedrich-Alexander University Erlangen-Nürnberg ( email )

Lange Gasse 20
Nuremberg, 90403
Germany
+499115302887 (Phone)
+499115302888 (Fax)

HOME PAGE: http://www.vwrm.rw.fau.de/

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