Valuation of Catastrophe Equity Puts With Markov‐Modulated Poisson Processes |
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| Authors: | Chia‐Chien Chang Shih‐Kuei Lin Min‐Teh Yu |
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| Institution: | 1. Chia‐Chien Chang is Assistant Professor of Finance, National Kaohsiung University of Applied Science, Kaohsiung 415, Taiwan.;2. Shih‐Kuei Lin is Associate Professor of Finance, National Chengchi University, Taipei 116, Taiwan.;3. Min‐Teh Yu is Professor of Finance, National Taiwan University and Providence University, Taipei 10617, Taiwan. |
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| Abstract: | We derive the pricing formula for catastrophe equity put options (CatEPuts) by assuming catastrophic events follow a Markov Modulated Poisson process (MMPP) whose intensity varies according to the change of the Atlantic Multidecadal Oscillation (AMO) signal. U.S. hurricanes events from 1960 to 2007 show that the CatEPuts pricing errors under the MMPP(2) are smaller than the PP by 30 percent to 66 percent. The scenario analysis indicates that the MMPP outperforms the exponential growth pattern (EG) if the hurricane intensity is the AMO signal, whereas the EG may outperform the MMPP if the future climate is warming rapidly. |
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