Value Adjustments and Dynamic Hedging of Reinsurance Counterparty Risk

Claudia Ceci, Katia Colaneri, Rüdiger Frey, Verena Köck

Publication: Scientific journalJournal articlepeer-review

Abstract

Reinsurance counterparty credit risk (RCCR) is the risk of a loss arising from the fact that a reinsurance company is unable to fulfill her contractual obligations toward the ceding insurer. RCCR is an important risk category for insurance companies which, so far, has been addressed mostly via qualitative approaches. In this paper we therefore study value adjustments and dynamic hedging for RCCR. We propose a novel model that accounts for contagion effects between the default of the reinsurer and the price of the reinsurance contract. We characterize the value adjustment in a reinsurance contract via a partial integro-differential equation and derive the hedging strategies using a quadratic method. The paper closes with a simulation study which shows that dynamic hedging strategies have the potential to significantly reduce RCCR.
Original languageEnglish
Pages (from-to)788 - 814
JournalSIAM Journal on Financial Mathematics
Volume11
Issue number3
DOIs
Publication statusPublished - 2020

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