Valuation of insurers’ contingent capital with counterparty risk and price endogeneity

Chien-Ling Lo, Jin-Ping Lee and Min-Teh Yu ()

Journal of Banking & Finance, 2013, vol. 37, issue 12, 5025-5035

Abstract: This study develops a structural framework to value insurers’ contingent capital with counterparty risk (CR) and overcomes the problem of price endogeneity (PE) in the valuation model. Our results on the focal contingent capital instrument – catastrophe equity put option (CatEPut) – indicate that prices can be significantly overestimated without considering CR and be significantly underestimated without considering PE. This study also examines how CatEPuts affect the buyer’s probability of default (PD). Our results show that buying a CatEPut lowers the PD for high-risk insurers, but not necessarily so for low-risk insurers; however, without taking CR and PE into account, one may significantly overestimate the credit enhancement provided by the CatEPuts.

Keywords: Contingent capital; Catastrophe risk; Insurer’s default risk; Catastrophe equity puts; Contingent claim analysis (search for similar items in EconPapers)
JEL-codes: G20 G21 G28 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (18)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:37:y:2013:i:12:p:5025-5035

DOI: 10.1016/j.jbankfin.2013.09.007

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