Designing a Counter-Cyclical Insurance Program for Systemic Risk
The Journal of Risk and Insurance, Forthcoming
Posted: 1 Feb 2012 Last revised: 24 Apr 2012
Date Written: October 25, 2011
This paper proposes a framework for measuring and managing systemic risk. Current solvency regulations have been criticized for their focus on individual firms rather than the system as a whole. We show how an insurance program can be designed to deal with systemic risk through a risk charge on participating institutions. The risk charge is based on the generalized CoCTE, a conditional risk measure, adapted from conditional VaR. Current regulations have been criticized on the grounds that their capital requirements are pro-cyclical. They require extra capital in periods of extreme stress thus exacerbating a crisis. We show how to construct a counter-cyclical risk charge and illustrate the approach using a numerical example.
Keywords: Systemic risk, pro-cyclical risk charge, risk capital, CoVaR, CoCTE, regime switching
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