Dynamic Physical Hedging amid Jump Losses, Reconstruction-Price Uncertainty, Population Interactions

Paramahansa Pramanik and Michael Bowdin

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Abstract: We study dynamic physical hedging for insurers exposed jointly to catastrophe losses and stochastic reconstruction costs. Surplus evolves as a controlled jump diffusion whose loss amplitude combines marked catastrophe severity, an exogenous mean-reverting cost factor, and endogenous mitigation. We establish well-posedness, moment and stability estimates, and a stopping-time dynamic programming principle, and prove that the value function is the unique viscosity solution of the resulting nonlocal Hamilton-Jacobi-Bellman (HJB) equation Strategic interaction is introduced through a mean field game (MFG) with reduced-form vulnerability costs, yielding a coupled backward-forward HJB-Kolmogorov system. We establish relaxed equilibrium existence, Markovian realization, and uniqueness under appropriate compactness and monotonicity conditions. Numerical experiments show that reconstruction costs and capitalization materially affect optimal hedging and that cross-sectional vulnerability alters equilibrium costs. Tail-family robustness calculations further assess the sensitivity of these conclusions to alternative catastrophe-severity specifications.

Date: 2026-08
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