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Valuation of Insurers' Contingent Capital with Counterparty Risk and Price Endogeneity
Jin-Ping Lee,Chien-Ling Lo,Min-Teh Yu 한국재무학회 2012 한국재무학회 학술대회 Vol.2012 No.09
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 - catastro- phe equity put option (CatEPut) - indicate that prices can easily be overestimated by 110 basis points without considering CR and be underestimated by 17{34 basis points without considering PE. This study also examines how CatEPuts aect the buyer's probability of default (PD). Our results show that buying CatEPut lowers the buyer's PD; however, if we ignore the new equity eect due to share issuance, the result is not true in some scenarios. Without taking CR and PE into account, one may signicantly overestimate the credit enhancement provided by the CatEPuts.