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Related Concept Videos

Actuarial Approach01:20

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The actuarial approach, a statistical method originally developed for life insurance risk assessment, is widely used to calculate survival rates in clinical and population studies. This method accounts for participants lost to follow-up or those who die from causes unrelated to the study, ensuring a more accurate representation of survival probabilities.
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An Actuarial Pricing Method for Air Quality Index Options.

Zhuoxin Liu1, Laijun Zhao2,3, Chenchen Wang1

  • 1School of Economics and Management, Shaanxi University of Science and Technology, Xi'an 710021, China.

International Journal of Environmental Research and Public Health
|December 11, 2019
PubMed
Summary

This study introduces Air Quality Index (AQI) options to help businesses manage financial risks from air pollution. These options provide a hedging strategy against operational disruptions caused by poor air quality.

Keywords:
Ornstein–Uhlenbeck modelactuarial pricingair quality indexoptionsrisk hedging

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Area of Science:

  • Environmental Economics
  • Financial Risk Management
  • Atmospheric Science

Background:

  • Poor air quality negatively impacts social and economic activities.
  • Financial derivatives are crucial for risk hedging.
  • Enterprises face operational risks due to air pollution.

Purpose of the Study:

  • To develop and price Air Quality Index (AQI) options for hedging enterprise operational risks.
  • To establish a framework for using AQI options in financial risk management.
  • To demonstrate the practical application of AQI options for businesses affected by air pollution.

Main Methods:

  • Utilized an expanded Ornstein-Uhlenbeck model with AR-GARCH to predict Air Quality Index (AQI).
  • Constructed an average AQI as the underlying index for AQI options.
  • Employed an actuarial pricing method with an Esscher transform for AQI options.
  • Developed payoff functions for hedging operational risks.

Main Results:

  • Successfully priced AQI options using data from Xi'an, China.
  • Demonstrated the application of AQI options for a tourism enterprise in hedging operational risk.
  • Validated the effectiveness of AQI options in mitigating financial losses from air pollution.

Conclusions:

  • AQI options offer a viable financial instrument for enterprises to hedge against operational risks associated with air pollution.
  • The developed methodology for AQI options is applicable to other cities and regions.
  • Trading AQI options can enhance business resilience in environments with significant air quality concerns.