Optimal risk management with reinsurance and its counterparty risk hedging

Yichun Chi, Tao Hu and Yuxia Huang

Insurance: Mathematics and Economics, 2023, vol. 113, issue C, 274-292

Abstract: In this paper, we revisit the study of an optimal risk management strategy for an insurer who wants to maximize the expected utility by purchasing reinsurance and managing reinsurance counterparty risk with a default-free hedging instrument, where the reinsurance premium is calculated by the expected value principle and the price of the hedging instrument equals the expected payoff plus a proportional loading. Different to previous studies, we exclude ex post moral hazard by imposing the no-sabotage condition on reinsurance contracts and derive the optimal strategy analytically. We find that the stop-loss reinsurance is always optimal, but the form of the optimal hedging payoff depends on the cost difference between reinsurance and hedging instrument. We further show that full risk transfer is optimal if and only if both reinsurance pricing and the hedging price are fair. Finally, numerical analyses are conducted to illustrate the effects of some interesting factors on the optimal risk management strategy.

Keywords: Risk management; Counterparty risk; Hedging; Mossin's theorem; No-sabotage condition (search for similar items in EconPapers)
JEL-codes: D81 G22 G33 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:113:y:2023:i:c:p:274-292

DOI: 10.1016/j.insmatheco.2023.09.003

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