The pricing of loan insurance based on the Gram-Charlier option model. Issue 4 (19th November 2018)

• Record Type: Journal Article
• Authors: Zhang, Yaojie; Wei, Yu; Shi, Benshan
• Is Part Of: China finance review international. Volume 8:Issue 4(2018)
• Page Start: 425
• Page End: 440
• Publication Date: 2018-11-19
• Subjects: Pricing model -- Skewness -- Kurtosis -- Gram-Charlier option -- Loan insurance; G21 -- G22; Finance -- China -- Periodicals; Investments, Foreign -- China -- Periodicals; China -- Economic policy -- Periodicals; 332.095105
• DOI: 10.1108/CFRI-10-2017-0210
• Languages: English
• ISSNs: 2044-1398

Abstract

Abstract : Purpose: The purpose of this paper is to develop a loan insurance pricing model allowing for the skewness and kurtosis existing in underlying asset returns. Design/methodology/approach: Using the theory of Gram-Charlier option, the authors first derive a closed-form solution of the Gram-Charlier pricing model. To address the difficulties in implementing the pricing model, the authors subsequently propose an iterative method to estimate skewness and kurtosis in practical application, which shows a relatively fast convergence rate in the empirical test. Findings: Not only the theoretical analysis but also the empirical evidence shows that the effects of skewness and kurtosis on loan insurance premium tend to be negative and positive, respectively. Furthermore, the actual values of skewness and kurtosis are usually negative and positive, respectively, which leads to the empirical result that the pricing model ignoring skewness and kurtosis substantially underestimates loan insurance premium. Originality/value: This paper proposes a loan insurance pricing model considering the skewness and kurtosis of asset returns, in which the authors use the theory of Gram-Charlier option. More importantly, the authors further propose a novel iterative method to estimate skewness and kurtosis in practical application. The empirical evidence suggests that the Gram-Charlier pricing model captures the information content of skewness and kurtosis.