Hostname: page-component-cd9895bd7-lnqnp Total loading time: 0 Render date: 2024-12-23T19:33:09.417Z Has data issue: false hasContentIssue false
  • English
  • Français

Asset Pricing Models and Insurance Ratemaking

Published online by Cambridge University Press:  29 August 2014

J. David Cummins
J. David Cummins*
Affiliation:
The Wharton School of the University of Pennsylvania, Philadelphia, USA
*
Department of Insurance, The Wharton School of the University of Pennsylvania, 3641 Locust Walk, Philadelphia, PA 19104-6218, USA.
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

This paper provides an introduction to asset pricing theory and its applications in non-life insurance. The first part of the paper presents a basic review of asset pricing models, including discrete and continuous time capital asset pricing models (the CAPM and ICAPM), arbitrage pricing theory (APT), and option pricing theory (OPT). The second part discusses applications in non-life insurance. Among the insurance models reviewed are the insurance CAPM, discrete time discounted cash flow models, option pricing models, and more general continuous time models. The paper concludes that the integration of actuarial and financial theory can provide major advances in insurance pricing and financial management.

Keywords

Asset pricing modelsfinancial pricing modelsinsurance pricingportfolio theoryoption pricingcapital asset pricing modelarbitrage pricing theorydiscounted cash flow modelsinsurance default risk
Type
Invited Paper
Information
ASTIN Bulletin: The Journal of the IAA , Volume 20 , Issue 2 , November 1990 , pp. 125 - 166
Copyright
Copyright © International Actuarial Association 1990

References

Abramowitz, Milton and Stegun, Irene (1970) Handbook of Mathematical Functions (New York: Dover Publications).Google Scholar
Ang, James S. and Lai, Tsong-Yue (1987) Insurance Premium Pricing and Ratemaking in Competitive Insurance and Capital Asset Markets. Journal of Risk and Insurance 54, 767–779.CrossRefGoogle Scholar
Biger, Nihum and Kahane, Yehuda (1978) Risk Considerations In Insurance Ratemaking. Journal of Risk and Insurance 45, 121–132.CrossRefGoogle Scholar
Black, Fischer and Scholes, Myron (1973) The Pricing of Options and Corporate Liabilities. Journal of Political Economy 81, 637–654.CrossRefGoogle Scholar
Borch, Karl (1974) The Mathematical Theory of Insurance. (Lexington, MA: Lexington Books).Google Scholar
Boyle, Phelim (1988) A Lattice Framework for Option Pricing With Two State Variables. Journal of Financial and Quantitative Analysis 23, 1–12.CrossRefGoogle Scholar
Brealey, Richard A. and Myers, Stewart C. (1988) Principles of Corporate Finance, 3rd ed. (New York: McGraw-Hill Book Company).Google Scholar
Breedon, D. T. (1979) An Intertemporal Asset Pricing Model with Stochastic Investment and Consumption Opportunities. Journal of Financial Economics 6, 273–296.Google Scholar
Brennan, M.J. (1979) The Pricing of Contingent Claims In Discrete Time Models. Journal of Finance 24, 53–68.CrossRefGoogle Scholar
Buhlmann, Hans (1980) An Economic Premium Principle. ASTIN Bulletin 11, 52–60.CrossRefGoogle Scholar
Buhlmann, Hans (1984) The General Economic Premium Principle. ASTIN Bulletin 14, 13–21.CrossRefGoogle Scholar
Cooper, Robert W. (1974) Investment Return and Property-Liability Insurance Ratemaking (Philadelphia: S.S. Huebner Foundation, University of Pennsylvania).Google Scholar
Cox, John D. and Ross, Stephen (1976) The Valuation of Options for Alternative Stochastic Processes. Journal of Finance 31, 383–402.CrossRefGoogle Scholar
Cox, John D. and Rubinstein, Mark (1985) Options Markets. (Englewood Cliffs, N.J.: Prentice-Hall).Google Scholar
Copeland, Thomas E. and Weston, J. Fred (1988) Financial Theory and Corporate Policy, 3d. ed. (Reading, MA: Addison-Wesley Publishing Company).Google Scholar
Cummins, J. David (1988a) Risk-Based Premiums for Insurance Guaranty Funds. Journal of Finance 43, 823–839.Google Scholar
Cummins, J. David (1988b) Capital Structure and Fair Profits In Property-Liability Insurance, working paper, University of Pennsylvania.Google Scholar
Cummins, J. David (1990) Multi-Period Discounted Cash Flow Ratemaking Models In Property-Liability Insurance. Journal of Risk and Insurance 57, 79–109.CrossRefGoogle Scholar
Cummins, J. David and Chang, Lena (1983) An Analysis of the New Jersey Formula for Including Investment Income In Property-liability Insurance Ratemaking. Journal of Insurance Regulation 1, 555–573.Google Scholar
Cummins, J. David and Derrig, Richard A. (1989) Financial Models of Insurance Solvency (Norwell, MA: Kluwer Academic Publishers).CrossRefGoogle Scholar
Cummins, J. David and Harrington, Scott E. (1985) Property-Liability Insurance Rate Regulation: Estimation of Underwriting Betas Using Quarterly Profit Data. Journal of Risk and Insurance 52, 16–43.CrossRefGoogle Scholar
Cummins, J. David and Harrington, Scott E. (1987) Fair Rate of Return In Property-Liability Insurance (Norwell, MA: Kluwer Academic Publishers).CrossRefGoogle Scholar
D'Arcy, Stephen and Doherty, Neil A. (1988) Financial Theory of Insurance Pricing (Philadelphia: S.S. Huebner Foundation).Google Scholar
D'Arcy, Stephen and Garven, James R. (1988) Financial Pricing Models of Property-Liability Insurance: An Empirical Evaluation, working paper, The Pennsylvania State University.Google Scholar
Derrig, Richard A. (1985) The Effect of Federal Income Taxes on Investment Income in Property-Liability Ratemaking, working paper, Automobile Insurers Rating Bureau of Massachusetts, Boston, MA.Google Scholar
Doherty, Neil A. and Garven, James R. (1986) Price Regulation in Property-Liability Insurance: A Contingent Claims Approach. Journal of Finance 41, 1031–1050.Google Scholar
Duffie, Darrell (1988) Security Markets: Stochastic Models (New York: Academic Press).Google Scholar
Fairley, William (1979) Investment Income and Profit Margins In Property-Liability Insurance: Theory and Empirical Tests. Bell Journal 10, 192–210.CrossRefGoogle Scholar
Fama, Eugene F. (1977) Risk-Adjusted Discount Rates and Capital Budgeting Under Uncertainty. Journal of Financial Economics 4, 3–21.CrossRefGoogle Scholar
Greenwald, Bruce C. and Stiglitz, Joseph E. (1990) Asymmetric Information and the New Theory of the Firm: Financial Constraints and Risk Behavior. American Economic Review 80, 160–165.Google Scholar
Hill, Raymond (1979) Profit Regulation in Property-Liability Insurance. Bell Journal 10, 172–191.CrossRefGoogle Scholar
Ingersoll Jonathan, E. Jr. (1987) Theory of Financial Decision Making (Totowa, NJ: Rowman & Littlefield).Google Scholar
Jarrow, Robert (1988) Finance Theory (Englewood Cliffs, NJ: Prentice-Hall).Google Scholar
Jarrow, Robert and Rudd, Andrew (1983) Option Pricing (Homewood, IL: Richard D. Irwin).Google Scholar
Kahane, Yehuda (1979) The Theory of Insurance Risk Premiums — A Re-examination in the Light of Recent Developments in Capital Market Theory. ASTIN Bulletin 10, 223–239.CrossRefGoogle Scholar
Karlin, Samuel and Taylor, Howard (1981) A Second Course In Stochastic Processes (New York: Academic Press).Google Scholar
Kraus, Alan and Ross, Stephen (1982) The Determination of Fair Profits for the Property-Liability Insurance Firm. Journal of Finance 33, 1015–1028.Google Scholar
Levy, Haim and Sarnat, Marshall (1984) Portfolio and Investment Selection: Theory and Practice (Englewood Cliffs, NJ: Prentice-Hall).Google Scholar
Markowitz, Harry (1952) Portfolio Selection. Journal of Finance 7, 77–91.Google Scholar
Markowitz, Harry (1959) Portfolio Selection: Efficient Diversification of Investment (New York: John Wiley & Sons).Google Scholar
Mayers, David and Smith, Clifford W. (1982) On the Corporate Demand for Insurance. Journal of Business 55, 281–296.CrossRefGoogle Scholar
Merton, Robert C. (1973a) Theory of Rational Option Pricing. Bell Journal of Economics and Management Science 4, 141–183.Google Scholar
Merton, Robert C. (1973b) An Intertemporal Capital Asset Pricing Model. Econometrica 41, 867–880.CrossRefGoogle Scholar
Merton Robert, C. (1976) Option Prices Where Underlying Stock Returns Are Discontinuous. Journal of Financial Economics 3, 125–144.CrossRefGoogle Scholar
Muller, H.H. (1988) Modern Portfolio Theory: Some Main Results. ASTIN Bulletin 18, 127–146.CrossRefGoogle Scholar
Myers, Stewart and Cohn, Richard (1987) Insurance Rate Regulation and the Capital Asset Pricing Model, in Cummins, J. D. and Harrington, S. E., eds., Fair Rate of Return In Property-Liability Insurance (Norwell, MA: Kluwer Academic Publishers).Google Scholar
Owen, Joel and Rabinovitch, Ramon (1983) On the Class of Elliptical Distributions and Their Applications to the Theory of Portfolio Choice. Journal of Finance 38, 745–752.CrossRefGoogle Scholar
Roll, Richard (1977) A Critique of the Capital Asset Pricing Theory's Tests: Part I: On Past and Potential Testability of the Theory. Journal of Financial Economics 4, 129–176.CrossRefGoogle Scholar
Roll, Richard and Ross, Stephen A. (1980) An Empirical Investigation of the Abritrage Pricing Theory. Journal of Finance 35, 1073–1104.CrossRefGoogle Scholar
Ross, Stephen A. (1976) The Arbitrage Theory of Capital Asset Pricing. Journal of Economic Theory 13, 341–360.CrossRefGoogle Scholar
Ross, Stephen A. (1977) Risk, Return, and Arbitrage, in Friend, I. and Bicksler, J., eds., Risk and Return in Finance, v.I. (Cambridge, MA: Ballinger Publishing Co.).Google Scholar
Ross, Stephen A. and Westerfield, Randolph (1988) Corporate Finance (St. Louis, MO: Times Mirror/Mosby College Publishing).Google Scholar
Rothschild, Michael and Stiglitz, Joseph E. (1970) Increasing Risk I: A definition. Journal of Economic Theory 2, 225–243.CrossRefGoogle Scholar
Rothschild, Michael and Stiglitz, Joseph E. (1972) Increasing Risk II: Its Economic Consequences. Journal of Economic Theory 3, 66–84.CrossRefGoogle Scholar
Rothschild, Michael and Stiglitz, Joseph E. (1976) Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information. Quarterly Journal of Economics 90, 629–650.CrossRefGoogle Scholar
Schweizer, M. and Follmer, H. (1988) Hedging By Sequential Regression: An Introduction to the Mathematics of Options Trading. ASTIN Bulletin 18, 147–160.Google Scholar
Turner, Andrew L. (1987) Insurance in an Equilibrium Asset Pricing Model, in Cummins, J.D. and Harrington, S. E., eds., Fair Rate of Return in Property-Liability Insurance (Norwell, MA: Kluwer Academic Publishers).Google Scholar