Basis risk management and randomly scaled uncertainty

M. Mercè Claramunt, Claude Lefèvre, Stéphane Loisel and Pierre Montesinos

Insurance: Mathematics and Economics, 2022, vol. 107, issue C, 123-139

Abstract: This paper proposes a method for quantifying the basis risk present in index-based insurance. It applies when the inherent uncertainty is represented by a randomly scaled variable. This turns out to be a reasonable assumption in a number of practical situations. Several properties of such a variable are first briefly studied. Their order in the s-convex sense is discussed and the associated extreme distributions are obtained to generate the worst situations. In each scenario, the basis risk consequences are then assessed using a penalty function that takes into account the risk tolerances of the protection buyer. Basis risk limits for a fixed budget can also be set. The proposed approach is illustrated by a few simple examples.

Keywords: Basis risk; Index-based insurance; Randomly scaled variables; s-convex orders; Penalty functions (search for similar items in EconPapers)
JEL-codes: C02 C44 G22 G32 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:107:y:2022:i:c:p:123-139

DOI: 10.1016/j.insmatheco.2022.08.005

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