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Quasi risk-neutral pricing in insurance


Niederau, Harry; Zweifel, Peter (2009). Quasi risk-neutral pricing in insurance. ASTIN Bulletin, 39(1):317-337.

Abstract

This contribution shows that for certain classes of insurance risks, pricing can be based on expected values under a probability measure P* amounting to quasi risk-neutral pricing. This probability measure is unique and optimal in the sense of minimizing the relative entropy with respect to the actuarial probability measure P, which is a common approach in the case of incomplete markets. After expounding the key elements of this theory, an application to a set of industrial property risks is developed, assuming that the severity of losses can be modeled by 'Swiss Re Exposure Curves', as discussed by Bernegger (1997). These curves belong to a parametric family of distribution functions commonly used by pricing actuaries. The quasi risk-neutral pricing approach not only yields risk exposure specific premiums but also Risk Adjusted Capital (RAC) values on the very same level of granularity. By way of contrast, the conventional determination of RAC is typically considered on a portfolio level only.

This contribution shows that for certain classes of insurance risks, pricing can be based on expected values under a probability measure P* amounting to quasi risk-neutral pricing. This probability measure is unique and optimal in the sense of minimizing the relative entropy with respect to the actuarial probability measure P, which is a common approach in the case of incomplete markets. After expounding the key elements of this theory, an application to a set of industrial property risks is developed, assuming that the severity of losses can be modeled by 'Swiss Re Exposure Curves', as discussed by Bernegger (1997). These curves belong to a parametric family of distribution functions commonly used by pricing actuaries. The quasi risk-neutral pricing approach not only yields risk exposure specific premiums but also Risk Adjusted Capital (RAC) values on the very same level of granularity. By way of contrast, the conventional determination of RAC is typically considered on a portfolio level only.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Economics
Dewey Decimal Classification:330 Economics
Language:English
Date:2009
Deposited On:20 Jan 2010 13:03
Last Modified:05 Apr 2016 13:31
Publisher:Peeters
ISSN:0515-0361
Publisher DOI:https://doi.org/10.2143/AST.39.1.2038067
Permanent URL: https://doi.org/10.5167/uzh-23642

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