Contagion Prof. dr. Roger J. A. Laeven September 6, 2012 C ONTAGION - - PowerPoint PPT Presentation

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Contagion Prof. dr. Roger J. A. Laeven September 6, 2012 C ONTAGION - - PowerPoint PPT Presentation

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Amsterdam School of Economics Contagion Prof. dr. Roger J. A. Laeven September 6, 2012 C ONTAGION Challenges in Risk and Insurance Inaugural Lecture delivered upon appointment to the chair of Full Professor of Risk and Insurance at the

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Contagion

  • Prof. dr. Roger J. A. Laeven

September 6, 2012

Amsterdam School of Economics

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Inaugural Lecture R.J.A. Laeven 2

CONTAGION

Challenges in Risk and Insurance

Inaugural Lecture

delivered upon appointment to the chair of Full Professor of Risk and Insurance at the University of Amsterdam

  • n Thursday 6 September 2012

by

  • Prof. dr. Roger J. A. Laeven
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Inaugural Lecture R.J.A. Laeven 3

1988

 Roger “Urbanus” Laeven

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Inaugural Lecture R.J.A. Laeven 4

2012

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Inaugural Lecture R.J.A. Laeven 5

2012

 Sit back, relax and

enjoy your stay.

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Inaugural Lecture R.J.A. Laeven 6

September 21, 2005

 Essays on Risk Measures

and Stochastic Dependence, with Applications to Insurance and Finance.

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Inaugural Lecture R.J.A. Laeven 7

September 6, 2012

 Contagion: Challenges in

Risk and Insurance.

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Inaugural Lecture R.J.A. Laeven 8

Outline

 A Brief History of Risk and Insurance  Basic Principles of Risk and Insurance  Risk and Insurance: Stochastics and Economics  Challenges in Risk and Insurance  Future of Risk and Insurance  Tot Slot

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Inaugural Lecture R.J.A. Laeven 9

Jacob (James) Bernoulli

 1691  Law of Large Numbers

(Wet van de Grote Aantallen)

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Inaugural Lecture R.J.A. Laeven 10

Excerpt of the Bernoulli Family Tree

Nicolaus Jacob Nicolaus Johann Nicolaus Daniel

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Inaugural Lecture R.J.A. Laeven 11

Jacob Bernoulli

 Law of Large Numbers:

“The average loss in an expanding pool of risks eventually becomes certain (or predictable).”

 Pooling risks can serve as a basic risk mitigation

technique.

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Inaugural Lecture R.J.A. Laeven 12

Jacob Bernoulli

 Acta Eruditorum  Correspondences with Leibniz  Monumentum aere perennius (Horace)

(Een monument duurzamer dan brons)

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Daniel Bernoulli

 1731  Risk Measurement and

Utility

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Daniel Bernoulli

 Expectations are no proper descriptions of risk.  St. Petersburg paradox.  Subjective elements (utilities).

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Outline

 A Brief History of Risk and Insurance  Basic Principles of Risk and Insurance  Risk and Insurance: Stochastics and Economics  Challenges in Risk and Insurance  Future of Risk and Insurance  Tot Slot

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Law of Large Numbers

 Implications poorly understood.  “The average loss in an expanding pool of risks

eventually becomes certain (or predictable).”

 Average not aggregate  Pooling large numbers of risks

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Car

 Frederike Laeven, 3 years

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Example I: 1 car

Probability 99% 1% Loss EUR 0 EUR 10,000

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Pool of Cars

 Matthijs Laeven, 5 years

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Example I: 1,000 cars

Probability 99% 1% Loss EUR 0 EUR 10,000 Probability 99.999% 0.001% Average Loss ≤EUR 250 >EUR 250

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Inaugural Lecture R.J.A. Laeven 21

Example I: 1,000,000 cars

Probability 99% 1% Loss EUR 0 EUR 10,000 Probability 99.999% 0.001% Average Loss ≤EUR 104.26 >EUR 104.26

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Lesson

 “While the loss of a single individual may be

highly unpredictable, the average loss, averaged

  • ver an expanding pool of risks, eventually

becomes predictable: EUR 100.”

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Fallacies

 Average versus Aggregate  Independent versus Dependent  Infinite versus Finite

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Example II: Average vs. Aggregate (1,000 cars)

Probability 99.999% 0.001% Average Loss ≤EUR 250 >EUR 250 Probability 95% 5% Aggregate Loss ≤EUR 150,000 >EUR 150,000

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Vulcano

 Simon Laeven, 7 years

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Example III: Independent vs. Dependent

Probability 99% 0.9% 0.1% Loss EUR 0 EUR 10,000 EUR 10,000 Probability 99% 1% Loss EUR 0 EUR 10,000

Similar to Example I:

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Example III: Independent vs. Dependent

Probability 0.1% Average Loss EUR 10,000 Probability 99.999% 0.001% Average Loss ≤EUR 104.26 >EUR 104.26

Not similar to Example I:

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Independent vs. Dependent

Examples of Systematic Insurance Risks:

 Longevity  Interest rate

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Infinite vs. Finite

 “The expanding pool of risks, eventually pooling

infinitely many risks, only exists in the mathematician’s imagination.”

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Basic Principle?

 Pooling of risks does not lead to risk reduction

  • n the aggregate level of the pool.

 Why is the Law of Large Numbers is at the core

  • f risk and insurance?
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???

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Owners: Risk Pooling and Risk Spreading

 Matthijs Laeven, 5 years

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Outline

 A Brief History of Risk and Insurance  Basic Principles of Risk and Insurance  Risk and Insurance: Stochastics and Economics  Challenges in Risk and Insurance  Future of Risk and Insurance  Tot Slot

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Fundamental Questions

 How to measure risk?  How to price risk?  How to deal with dependences between risks?

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Risk and Stochastics: Idea and Language*

Probability Theory Economic Theory Mathematical Financial Statistics Economics Financial Insurance Mathematics Economics Insurance Econometrics Mathematics

*Source: Norberg

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Outline

 A Brief History of Risk and Insurance  Basic Principles of Risk and Insurance  Risk and Insurance: Stochastics and Economics  Challenges in Risk and Insurance  Future of Risk and Insurance  Tot Slot

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Risk Measures

 Axiomatic characterization:

Economic properties of risk measures <===> Mathematical representation of risk measures

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Risk Measures

 Implications for

 Risk management and capital requirements;  Pricing in incomplete markets; and  Portfolio choice and asset allocation.

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Contagion

 Linguistically, contagion is synonymous with

infection.

 Main challenge in Risk and Insurance.

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Contagion

 Transmission of shocks takes place:

in space (across countries or regions of the world) and in time (successive shocks in affected countries)

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Contagion

 Shocks

generated from

  • ur model

self-excite and cross-excite mimicking the patterns in the data.

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Contagion

 Earthquake analogy.  Non in cauda sed in caudis venenum (Laeven)

(Niet in de staart maar in de staarten zit het venein)

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Contagion

 Implications for

 Risk management and capital requirements;  Pricing; and  Portfolio choice and asset allocation.

 “This matters because the risk management

technique of diversification fails to be rewarding when it is needed most urgently.”

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Outline

 A Brief History of Risk and Insurance  Basic Principles of Risk and Insurance  Risk and Insurance: Stochastics and Economics  Challenges in Risk and Insurance  Future of Risk and Insurance  Tot Slot

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Insurers and Pensions

 “Against this backdrop, there are important

  • pportunities for insurers to develop transparent

and intelligent pension contracts, with unconditional promises and guarantees.”

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Insurer Solvency and Supervision

 “The time dimension should be acknowledged

and more explicitly incorporated in solvency supervision.”

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Education in Risk and Insurance

 “Integrated approaches to Risk and Insurance,

and specifically Integrated Risk Management, will become a central part of the education programs.”

 Amsterdam Executive MSc Insurance Studies  MSc Actuarial Science and Mathematical Finance  Amsterdam Executive MSc Actuarial Science

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Education in Risk and Insurance

 Actuarial Society (AG-AI)  Tinbergen Institute Graduate School

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Outline

 A Brief History of Risk and Insurance  Basic Principles of Risk and Insurance  Risk and Insurance: Stochastics and Economics  Challenges in Risk and Insurance  Future of Risk and Insurance  Tot Slot

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Contagion

 “Financial contagion: crucial challenge and

exciting research.” (“Besmettingsgevaar in financiële markten: cruciale uitdaging en aanstekelijke problematiek.”)

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Enjoying Modern Actuarial Risk Theory

 Simon, Matthijs en

Frederike Laeven.

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Full text

Full text of the inaugural lecture is available from:

http://www.rogerlaeven.com/

(then under Miscellaneous -> Inaugural Lecture)