Valuation of insurers’ contingent capital with counterparty risk and price endogeneity |
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Authors: | Chien-Ling Lo Jin-Ping Lee Min-Teh Yu |
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Institution: | 1. Department of Finance, National Taiwan University, Taiwan;2. Department of Finance, Feng Chia University, Taichung, Taiwan;3. Institute of Finance, National Chiao Tung University and RIRC, NCCU, Taiwan |
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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. |
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Keywords: | G20 G28 G21 |
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