“Leapfrogging” the variance: The financial management of extreme-event risk

Abstract

The events of September 11, 2001 have triggered great interest in the identification, assessment, and management of “extreme events.” In this article, we offer a new mathematical framework for the development of financial risk management techniques to address these exposures. Based upon our analysis, we argue that: (1) the decreasing marginal utility of net wealth does not adequately explain the economics of insurance/ reinsurance; and (2) our proposed apprehended value criterion provides approximate justification of mean-third central moment fourth central moment (M-T-F) decision making, thereby “leapfrogging” (skipping over) the variance. Appropriate extensions of traditional financial risk management concepts are then considered, along with their implications for insurer/reinsurer underwriting and investment activity.

Citation

Powers, M.R. (2002), "“Leapfrogging” the variance: The financial management of extreme-event risk", Choi, J.J. and Powers, M.R. (Ed.) Global Risk Management: Financial, Operational, and Insurance Strategies (International Finance Review, Vol. 3), Emerald Group Publishing Limited, Leeds, pp. 39-58. https://doi.org/10.1016/S1569-3767(02)03006-6