Hedging Catastrophe Risk Using Index-Based Reinsurance Instruments

Topics:
Insurance
Tags:
Business Operations,
Casualty Actuarial Society,
Corporate Insurance,
Insurance,
Reinsurance
Source:
Casualty Actuarial Society

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Overview: Index-based hedging instruments such as industry loss warranties are increasingly recognized as effective hedging tools for insurance and reinsurance portfolios. This study presents a systematic approach for potential buyers to analyze and manage basis risk in order to take full advantage of the benefits offered by these instruments. It examines two measures of basis risk: hedging effectiveness and conditional payoff shortfall. Many existing measures such as hedge volatility and correlation are special cases of the hedging effectiveness measure. Next, it studies the tradeoff between basis risk and the cost of hedging. Finally, it presents a robust numerical algorithm designed to optimize an index-based hedging program consisting of multiple index-based contracts.

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Format: PDF | Size: 704KB | Date: Mar 2004 | Pages: 24

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