Pricing and Risk Mitigation Analysis of a Cyber Liability Insurance using Gaussian, t and Gumbel Copulas – A case for Cyber Risk Index

Shah, Anand (2016): Pricing and Risk Mitigation Analysis of a Cyber Liability Insurance using Gaussian, t and Gumbel Copulas – A case for Cyber Risk Index.

Abstract

Cyber risk, a type of operational risk, is today considered a key component in the enterprise risk management framework. Under BASEL regulations, a bank could recognize the risk mitigating impact of the Cyber Liability Insurance (CLI) contract while calculating the minimum operational risk capital requirement. Despite this benefit and the onerous data protection acts, organizations are still reluctant to buy CLI contracts. In this work, we price and analyze a CLI contract using Gaussian, t and Gumbel copulas and evaluate the contract’s cyber risk mitigation effectiveness. We find that the current structure of the CLI contract with the limits and sub-limits may be inefficient at mitigating the cyber risk especially if the cyber risk losses were correlated and showed upper tail dependency. We then propose a case for a traded index for the cyber risk similar to the Property Claim Services (PCS) index for the catastrophic risk. A traded cyber risk index could offer wider cyber risk hedging alternatives to the insurers. Given such risk hedging alternatives, the insurers may have lower impetus to set conservative limits in the CLI contracts thus making the contracts more effective in mitigating the cyber risk of the organizations.

• Item Type: MPRA Paper
• Language: English
• Keywords: Interplay between finance and Insurance, cyber risk index, cyber liability insurance pricing, Gaussian, t and Gumbel copulas, operational risk, value at risk (VaR), conditional tail expectation (CTE), BASEL regulations, pricing of contingent claims in incomplete markets, Monte Carlo simulations
• Subjects: G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; G - Financial Economics > G2 - Financial Institutions and Services > G22 - Insurance ; Insurance Companies ; Actuarial Studies; G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation

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