The first category of contracts considered essentially fails to take account of the fact that a rare extreme event – a tail risk – affecting the insured, can also affect the insurer and thus fail to pay out. These risk correlations have not always been taken into account by market participants or regulators in the past. Apparently robust balance sheets, insured against bad outcomes, can look extremely weak once a major system-wide event occurs. The paper considers a number of practical examples, mostly based on the use of credit default swaps (CDS) as the insurance instrument.
Published on
01 September 2011
Press release