A QUADRATIC HEDGING APPROACH TO COMPARISON OF CATASTROPHE INDICES

Ragnar Norberg () and Oksana Savina ()
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Ragnar Norberg: Université de Lyon, Université Lyon 1, Fondation Lyon 1, ISFA, Laboratoire SAF, EA 2429, FR-69366 Lyon, France;
Oksana Savina: Department of Statistics, London School of Economics, Houghton Street, London WC2A 2AE, United Kingdom

International Journal of Theoretical and Applied Finance (IJTAF), 2012, vol. 15, issue 04, 1-20

Abstract: The present study addresses the problem of designing a catastrophe derivative that insurers can use to hedge catastrophe-related losses in an incomplete market. The losses are modeled as a doubly stochastic compound Poisson process with shot-noise intensity. The hedging capability of a derivative is measured by the reduction of the mean squared hedging error resulting from optimal trading in the derivative. A general form of this measure is obtained in terms of the coefficients in the martingale dynamics of the loss process and the price process of the derivative. Six specific derivatives, with pay-offs depending in different ways on available catastrophe indices and portfolio data, are compared by the proposed criterion.

Keywords: Mean-variance hedging; doubly stochastic Poisson process; catastrophe insurance; design of derivatives (search for similar items in EconPapers)
Date: 2012
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DOI: 10.1142/S0219024912500306

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