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Pricing of Catastrophe Risk and the Implied Volatility Smile

Semir Ben Ammar ()

No 1617, Working Papers on Finance from University of St. Gallen, School of Finance

Abstract: Property-casualty (P&C) insurers are exposed to rare but severe natural disasters. This paper analyzes the relation between catastrophe risk and the implied volatility smile of insurance stock options. We find that the slope is significantly steeper compared to non-financials and other financial institutions. We show that this effect has increased over time, suggesting a higher risk compensation for catastrophic events. We are able to link the insurance-specific tail risk component derived from options with the risk spread from catastrophe bonds. Our results provide an accurate, high-frequency calculation for catastrophe risk linking the traditional derivatives market with insurance-linked securities (ILS).

Keywords: Implied volatility; Options; Catastrophe risk; Tail risk; Natural disasters (search for similar items in EconPapers)
JEL-codes: G12 G13 G14 G22 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk, nep-ias and nep-rmg
Date: 2016-07
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Persistent link: https://EconPapers.repec.org/RePEc:usg:sfwpfi:2016:17

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