Forecasting The Pricing Kernel of IBNR Claims Development In Property-Casualty Insurance

A new method of forecasting the pricing kernel, i.e., stochastic claim inflation or link ratio function, of incurred but not reported (IBNR) claims (in property casualty insurance) from residuals in a dynamic claims forecast model is presented. We employ a pseudo Kalman filter approach by using claims risk exposure estimates to reconstruct innovations in stochastic claims development. Whereupon we find that the pricing kernel forecast is a product measure of the innovations. We show how these results impact performance measurement including but not limited to risk-adjusted return on capital by and through insurance accounting relationships for adjusted underwriting results; and loss ratio or pure premium calculations. Additionally, we show how, in the context of Wold decomposition, diagnostics from our model can be used to compute signal to noise ratio for, and cross check, unobservable pricing kernels used to forecast claims. Furthermore, we prove that a single risk exposure factor connects seemingly unrelated specifications for loss link ratio, and claims volatility.IBNR claims ladder; claims reserve forecast; stochastic claim inflation; claims risk exposure; link ratio function; property-casualty insurance; insurance accounting

Modeling And Forecasting Imported Japanese Parts Content Of US Transplants: An Error Correction And State Space Approach

This paper provides a sectoral examination of the impact of trade policies and custom valuation procedures on estimating time varying import content of Japanese transplant automobiles. Using monthly data from 1985 to 1992, we introduce an error correction model (ECM) and a state space VAR model to purify trade data of measurement errors induced by unobserveable prices and customs valuation procedures. Data show that US import of Japanese auto parts are elastic to the fleet of active Japanese automobiles in the U.S., inelastic to transplant production and that disequilibrium adjustments relative to transplant production are corrected in one period. Further, changes in imports are responsive to the cyclical behavior of Big 3 production and the debt burden of automobile consumers. Moreover, we find that productivity trends in the automotive industry are not a significant determinant of imported parts. The model predicts that Japanese manufacturers will shift more production to the US in response to yen appreciation against the dollar. We show that whereas import content decreased following the Fair Trade in Parts Act and the Omnibus Trade and Competitiveness Act of 1988, it increased shortly thereafter and predictions are that it will continue to increase. Therefore the empirical evidence suggests that direct trade policies designed to reduce import content and increase domestic sourcing of auto parts are not effective in the long run.measurement error; error correction; state space forecasts; time varying import content

A Trade Policy Perspective On Import Quotas And The Substitution Effect

This paper focuses on the necessary conditions required in order to exploit the substitution effect which arises when there is a shift in demand induced by import quotas under imperfect competition. The protective policy succeeds if the substitution effect shifts in favor of goods produced by the domestic industry and this shift offsets foreign firms quota rents and the decrease in consumer welfare. While extant literature tends to focus on welfare loss associated with import quotas, in this paper social welfare analytics are produced and a trade policy decision rule for net welfare gain is obtained.Import quota, social welfare, substitution effect, trade policy decision rule.

Do Public Sector Contracts And Policy Towards Small Firms Matter?: Evidence From Women Business Enterprises

This paper provides an empirical investigation of the agency relationship between the public sector and small firms targeted for assistance by examining micro and macro data for a cross section of eligible women business enterprises (WBEs). Using hedonic sales and employment indices we find that 2% of firm sales is lost to negative gender externality. We show that under asymmetric information public sector transfers neither compensate for this loss of sales nor do they increase employment. When we impose transfer restrictions under perfect information, sales is unaffected but firms respond by increasing the amount of part time employees hired and do not increase full time employment. Moreover, we show that WBE presence at the state level depend on prime-contractor-sub-contractor relationships and that if long term contracts are offered then business risks are reduced and firms increase employment levels because of securitized sales. Further, formation of new WBEs are directly proportional to the amount of new small business loans provided in the economy after controlling for size and population effects. The evidence suggests that after President Richard Nixon signed Executive Order 11625 the velocity of new WBE formation is approximately 39% of the difference between policy targets and actual realization. We introduce an entrepreneurial reaction function which shows that firms react to private and public sector funding incentives but not to the level of education attainment and overall business formation in the economy. We find that agency problems provide incentives for firms to engage in strategic misrepresentation. Thus, the incidence of adverse selection in current transfer programs are as high as 60% in some instances; imposes an asymmetric residual loss on the public sector, and contrary to the goals of benevolent policy, transfers are skewed in favor of less needy firms.negative externalities, compensatory financial contracts, hedonic indices; business risk; entrepreneur reaction function

On behavioral Arrow Pratt risk process with applications to risk pricing, stochastic cash flows, and risk control

We introduce a closed form behavioural stochastic Arrow-Pratt risk process, decomposed into discrete asymmetric risk seeking and risk averse components that run on different local times in ϵ-disks centered at risk free states. Additionally, we embed Arrow-Pratt (“AP”) risk measure in a simple dynamic system of discounted cash flows with constant volatility, and time varying drift. Signal extraction of Arrow-Pratt risk measure shows that it is highly nonlinear in constant volatility for cash flows. Robust identifying restrictions on the system solution confirm that even for small time periods constant volatility is not a measure of AP risk. By contrast, time-varying volatility measures aspects of embedded AP risk. Whereupon maximal AP risk measure is obtained from a convolution of input volatility and idiosyncratic shocks to the system. We provide four applications for our theory. First, we find that Engle, Ng and Rothschild (1990) Factor-ARCH model for risk premia is misspecified because the factor price of risk is time varying and unstable. Our theory predicts that a hyper-ARCH correction factor is required to remove the Factor-ARCH specification. Second, when applied to analysts beliefs about interest rates and volatility, we find that AP risk measure is a feedback control over stochastic cash flows. Whereupon increased risk aversion to negative shocks to earnings increases volatility. Third, we use an oft cited example of Benes, Shepp and Witsenhausen (1980) to characterize a controlled AP diffusion for a conservative investor who wants to minimize the AP risk process for an asset. Fourth, we recover stochastic differential utility functional from the AP risk process and show how it is functionally equivalent to Duffie and Epstein’s (1992) parametrization.behavioural Arrow-Pratt risk process; asymmetric risk decomposition; asset pricing; Markov process; local martingale; local time change

Asymptotic Theory Of Stochastic Choice Functionals For Prospects With Embedded Comotonic Probability Measures

We introduce a monotone class theory of Prospect Theory's value functions, which shows that they can be replaced almost surely by a topological lifting comprised of a class of compact isomorphic maps that embed weakly co-monotonic probability measures, attached to state space, in outcome space. Thus, agents solve a signal extraction problem to obtain estimates of empirical probability weights for prospects under risk and uncertainty. By virtue of the topological lifting, we prove an almost sure isomorphism theorem between compact stochastic choice operators, and well defined outcomes which, under Brouwer-Schauder theory, guarantees fixed point convergence in convex choice sets. Along the way we introduce a risk operator in the Hoffman-Jorgensen class of lifting operators, and value function [averaging] operators with respect to Radon measure. In that set up, suitable binary operations on gain-loss space show that our risk operator is isometric for gains and skewed for losses. The point spectrum from this operator constitutes the range of admissible observations for loss aversion index in a well designed experiment.monotone class theorem; stochastic choice functional; embedded probability; comonotonic probability; isomorphism