Carolyn W. Chang works in the Department of Finance, California State University, Fullerton. Jack S. K. Chang and Min-Ming Wen work with the Department of Finance & Law, California State University, Los Angeles. The authors can be contacted via e-mail: email@example.com. We gratefully acknowledge the financial assistance from the Center for Insurance Studies at California State University, Fullerton, for a CIS Faculty Research Award.
Optimum Hurricane Futures Hedge in a Warming Environment: A Risk–Return Jump-Diffusion Approach
Article first published online: 8 NOV 2012
© The Journal of Risk and Insurance
Journal of Risk and Insurance
Volume 81, Issue 1, pages 199–217, March 2014
How to Cite
Chang, C. W., Chang, J. S. K. and Wen, M.-M. (2014), Optimum Hurricane Futures Hedge in a Warming Environment: A Risk–Return Jump-Diffusion Approach. Journal of Risk and Insurance, 81: 199–217. doi: 10.1111/j.1539-6975.2012.01492.x
- Issue published online: 13 FEB 2014
- Article first published online: 8 NOV 2012
We develop an optimum risk–return hurricane hedge model in a doubly stochastic jump-diffusion economy. The model's concave risk–return trade-off dictates that a higher correlation between hurricane power and insurer's loss, a smaller variable hedging cost, and a larger market risk premium result in a less costly but more effective hedge. The resulting hedge ratio comprises of a positive diffusion, a positive jump, and a negative hedging cost component. Numerical results show that hedging hurricane jump risks is most crucial with jump volatility being the dominant factor, and the faster the warming the more pronounced the jump effects.