An Equilibrium Model of Catastrophe Insurance Futures Contracts

This paper presents a valuation theory of futures contracts and derivatives on such contracts when the underlying delivery value follows a stochastic process containing jumps of random claim sizes at random time points of accident occurrence. Applications of the theory are made on insurance futures, a new risk-management instrument launched by the Chicago Board of Trade in 1992, anticipated to start soon in Europe, and perhaps also in other parts of the world in the near future. The welfare loss in ordinary insurance markets due to moral hazard and adverse selection is likely to be reduced due to this new market. Several closed pricing formulas are derived, both for futures contracts and for futures derivatives, such as caps, call options and spreads. The framework is that of general and partial economic equilibrium theory under uncertainty