Hedging, Cash Flows, and Firm Value: Evidence of an Indirect Effect

We extend previous research by considering the role of reinsurance in hedging underwriting risk, pricing risk, and investment risk. We consider a stochastic dynamic optimization model applied to the problem of insurance pricing under a competitive insurance market with a jump diffusion risk process. Our model seeks to maximize the expected utility of the insurer’s terminal wealth, incorporating the interaction of a stochastic process for the insurance price evolution, reinsurance, investment strategy, and the possible hedging effect between insurance liabilities and investment risk. We solve this optimization problem by constructing a Hamilton– Jacobi–Bellman (HJB) equation.