Writer aka Seller

buyer

Payoff ST-F

Payoff F

ST

ST

-F

F-ST

At the time when the transaction actually occurs, one of two parties generally will gain and the other will lose through forward contract. The buyer will gain (lose) when the spot price is greater(less) than forward price. It is because it is expensive (cheaper) to buy pre-specified asset in the spot market. The seller will gain (lose) when the spot price is less (greater) than forward price. It is because he does not maximise (does maximise) his profit by selling prespecified asset in the spot market. Let ST denote the spot price at maturity date T; F denotes the forward price. Mathematically speaking, the possible gains/losses for the buyer of forward contract is ST- F. On the other hand, the possible gains/losses for the seller of forward contract is F-ST.

Consider an amount X, which is invested for a single year at rate r per annum. In this scenario, if compounding occurs once a year, the terminal value of the investment is X(1+r). Similarly, if the compounding occurs k times per year at annual rate r, the terminal value of is: k r (1) X 1+ k Equation (1) is discrete compounding.

Continuous compounding involves allowing the number of compounding dates within a year to tend to infinity. In this case, if compounding occurs once a year at annual rate, the terminal value is Xer. Similarly, suppose the money is invested at annual rate r and is continuously compounded for n year. In this case, the terminal value of investment is Xern.

We can price the forward contract. Denote the current spot asset price as S0; oneperiod risk free rate is r. The period for forward contract is k period. Consider the two pair of investment strategies. The first investment strategy involves buying forward contract. The cost of purchasing forward contract is zero. At maturity, the forward contract yields SK FK. The second investment strategy involves borrowing FKe-rk at risk-free rate for k periods and then buying a unit of asset at spot price. The cost of the second investment strategy is S0 FKe-rk. The second investment strategy yields SK FK. The payoffs of two investment strategies are identical such that they pay SK-FK. This implies that both investment strategies should have identical costs. Given the cost of buying forward is zero, the no-arbitrage argument states that the following condition must hold: S0 FKe-rK = 0 (2) Rearrange (1): S0 = FKe-rK (3) FK = S0erK (4) Equation (4) is the no-arbitrage price for the k period forward contract.

Cost Now Investment Strategy 1 Buy Forwards Contract 0 Total Pay-off 0 Investment Strategy 2 Buy Stock -S0 Borrow at risk-free rate +Fe-rK Total Pay-off S0 - Fe-rK

Payoff at Maturity SK-FK SK-FK SK FK SK-FK

Pricing Currency Forward Contract Consider that investor has $1 and he has two alternative investment strategies. In one of the investment strategy, investor invests in the domestic risk-free asset. The investment in domestic risk-free asset yields $erK at maturity (period K). r is the domestic risk-free asset. In other investment strategy, investor invests in the foreign risk-free asset. In order to do so, investor must first exchange his domestic currency for foreign currency at the spot exchange rate, denoted by S. This exchange rate is quoted as the domestic price of a unit of foreign currency. Let foreign currency be Singaporean currency, denoted as SGD$. Hence, $1 is equivalent to foreign currency of SGD$S-1. The investor yields a terminal value of investment worth (1/S)erfK, where rf is foreign interest rate. To lock in the SGD dollar receipts from the foreign investment, investor sells the known proceeds forward at forward rate of F. Hence the SGD dollar receipts from the foreign investment are: (F/S)erfK.

Suppose that interest rate and exchange rate are known at the present date. Both investment strategies cost $S. Using no-arbitrage argument, the payoff of both investment strategies are the same, such that: (F/S)erfK = erK (5) Rearrange (5): (F/S) = erK/erfK (6) Simplify equation (6): (F/S) = erKe-rfK (7) (F/S) = e(r-rf)K (8) Rearrange equation (8): F = Se(r-rf)K(9) Equation (9) is the no-arbitrage K-period currency forward contract. This is also known as covered interest rate parity. Equation (9) tells us that forward exchange rate differs from the spot exchange rate by a factor. This factor is determined by the interest rate differential between respective countries.

Payoff

Payoff

ST

ST

For example, the margin trading of equity typically involves a margin of 50%. If investor borrows, he still needs to finance half of the investment cost. Furthermore, he has to finance further margin calls if the stock price goes down. In contrast, in future market, margins are usually less than 10 percent of the face value of securities. The futures contract is marked to market each day. Thus, investor can unwind his position sell (buy) if the original transaction was a buy (sell). His or her account is settled with no further cash flows taking place.

The holder of European-style call option only exercises the right to buy asset when the spot price exceeds the exercise price. In this case, he makes a gain of ST-X, where ST is spot price at period T and X is exercise price. Conversely, if the exercise price exceeds the spot price, he will not exercise. This is because it is cheaper to buy asset in spot market. Mathematically speaking, the payoff on the European-style call option can be expressed as: max [ST-X, 0]. The payoff on the European-style call option can be expressed graphically as follows:

Pay-off ST-X

ST

The holder of European-style put option only exercises the right to sell asset when the spot price is less than the exercise price. In this case, he makes a gain of X-ST. Conversely, if the exercise price exceeds the spot price, he will not exercise the right. This is because he is better off selling asset in spot price at higher price than exercise price. Mathematically speaking, the payoff on the European-style put option can be expressed as: max [X-ST, 0]. The payoff on the European-style put option can be expressed graphically as follows:

Pay-off

X-ST

ST

The payoff of the writers of European-style call and put options (right and left of diagrams respectively) can be expressed graphically as:
Pay-off Pay-off

ST

ST

-X-ST 0 0

-ST-X

The payoff of holders of European-style call and put options are always weakly positive, which means that they never have negative payoff. Thus, they have to pay call/put premium positive price- at the outset. This premium is the compensation to the writers of Europeanstyle call and put options. It is because the writers of European-style call and put options are exposed to only weakly negative cash flows in the future.

Binominal Option Pricing

Black Scholes Model

Binominal Option Pricing SH Probability = x $a Probability = 1-x SL

All derivatives are assumed to last only for one period. This means that they start today and end tomorrow. Furthermore, the price of the underlying asset, taking one of two values tomorrow is assumed to represent the uncertainty in our world. On one hand, if the state of the world is good, the tomorrows spot price is SH. On the other hand, if the state of the world is bad, the tomorrows spot price is SL. SH is greater than SL. The current price of the underlying asset is S0. Suppose that there is one-period derivative exist in our world. On one hand, if the state of the world is good, the derivative will pay KH. On the other hand, if the state of the world is bad, the derivative will pay KL. The one-period risk-free rate is rF. We need to construct a portfolio that contains the underlying asset and the risk-free asset. Using no-arbitrage arguments, this portfolio must have the same payoff as the derivative. Suppose that we buy units of the underlying asset and units of the risk-free asset.

If the state of the world tomorrow is good, the payoff of this portfolio and derivative is such that: SH + erF = KH (10) If the state of the world tomorrow is bad, the payoff of this portfolio and derivative is such that: SL + erF = KL (11) Subtracting equation (11) from equation (10): (SH-SL) = KH-KL (12) Rearrange equation (12): = (KH-KL)/(SH-SL) (13) Equation (13) provides the value of unit of underlying asset.

Substitute equation (13) into equation (10): [(KH-KL)/(SH-SL)]SH + erF= KH

(14)

Rearrange equation (14): erF = KH [SH[(KH-KL)/(SH-SL)]]

=e
-rF

(15)
(16)

(KH - SH) (KH-KL) (SH-SL)

Equation (16) provides the value of unit of underlying asset

Regardless of the state of the world, the payoff of the replicating portfolio is the same as that of derivative. In this case, the no-arbitrage argument states that the cost of replicating portfolio and derivative must be the same. Thus, the no-arbitrage price of the derivative at current period is: C = S0 + (17)

Black Scholes Option Pricing Suppose a stock pays no dividends before the expiration of an option. The return of this stock is lognormally distributed. The stock is assumed to traded continuously in frictionless capital market. This stock has constant standard deviation for risk-free rate. Suppose there is a call option with a exercise price of X and T years to expiration. The call option can be given by: c = SN(d1) Xe-rTN(d2) (18) where c is the call option, N(.) is cumulative normal distribution function, X is exercise price, r is the risk-free rate, T is the time to expiration. In(S/Xe-rT) d1 = + T T 2 d2 = d1 - T Equation (18) provides no-arbitrage prices for European and American call options on underlying securities with no cash dividends until expiration.

UK MNC in UK

+ i/r

US MNC $ + i/r in US

UK MNCs subsidiary in US

US MNCs subsidiary in UK

In the currency swap agreement, the companies deposited money with each other at the beginning of the period. During the periods in between beginning and end of the agreement, they paid the interim interest payment to each other according to the prevailing interest rates in the two currencies. At the end of the agreement, they would pay back the principal amounts to each other. In practice, payments are usually netted off so that, depending on the exchange rate at the time. Therefore, there is only one payment between the parties. Explain what a swap agreement is, why they are often used, and explain what counterparty risk in swap agreements is. Consider the cash flows of the two assets C and D below, which are both risk free. The owners of the assets agree to swap their respective assets. The risk free interest rate is 5% per annum for all maturities. How much should the owner of asset C pay the owner of asset D for the swap? Explain. Asset Cash Flow Yr 1 Cash Flow Yr 3 Cash Flow Yr 2 C 5 5 5 D 8 2 6.575 Answer: Value of differential cash flows in year 1 = 5-8 = -3 Value of differential cash flows in year 2 = 5-2 = 3 Value of differential cash flows in year 3 = 5-6.575 = -1.575 Present value of differential cash flow = [-3/1.05] + [3/1.052] + [-1.575/1.053] = -2.86 + 2.72 + (-1.36) = -1.50 Therefore, the owner of asset C pay $1.50 to owner of asset D for the compensation of the loss in value that owner of asset D has to bear.

Suppose two agents are quoted by their banks about the following interest rates on fixed and floating rate loans respectively.
Agent 1 2 Bank Quotes: Fixed Rate 3% 3.75% Bank Quotes: Floating Rate SIBOR + 0.5% SIBOR + 0.75%

Agent 1 wishes to borrow $100 million at floating rate while Agent 2 wishes to borrow the same amount at fixed rate. The lifetime of each loan is five years. SIBOR is Singapore Interbank Offer Rate. Suppose that Agent 1 borrows $100 million at the fixed rate 3% while Agent 2 borrows the same amount at a SIBOR + 0.75%. These are contrary to both their desires. They agree to participate to a swap. On each payment date, Agent 1 pays Agent 2 the floating rate of SIBOR and Agent 2 pays Agent 1 a fixed rate of 2.75%. Both are based on a notional principal of $100m. At each payment date, Agent 1 pays his bank fixed interest rate of 3% to his bank. At the same time, he receives fixed interest rate of 2.75% from Agent 2. In return, he pays Agent 2 SIBOR. Thus, Agent 1 pays SIBOR + 0.25% [= SIBOR + (3%-2.75%)]. This is 0.25% [=(SIBOR + 0.5%) (SIBOR + 0.25%)] lower than what Agent 1 could have borrowed directly from the bank. At each payment date, Agent 2 pays SIBOR + 0.75% to his bank. At the same time, he receives SIBOR from Agent 1. In return, he pays Agent 1 fixed interest rate of 2.75%. Thus, in total, Agent 2 pays 3.5% (SIBOR SIBOR + 0.75% + 2.75%). This is 0.25% (=3.75% - 3.5%) lower than Agent 2 could have borrowed directly from the bank.

This example illustrates that both agents have gained by participating in the swap. The bank offered Agent 1 a floating rate of SIBOR of 0.5% and offered Agent 2 a fixed rate of 3.75%. Both Agents 1 and 2 borrow in their less preferred market and entering into the swap. Each agent has profited. It is because Agents 1 and 2 have comparative advantage in fixed rate market and in floating rate market respectively. In this case, the swap allows the agents to exploit their comparative advantages. The swap also allows the agents to transform payments from fixed to floating rates or vice versa. The total gain will equal the difference between the fixed rates less the difference between the floating rates. In this case, the total gain is 0.5% (=0.25% + 0.25%) and this difference is also 0.5% [=(3.75%-3%) [(SIBOR+0.75%) (SIBOR + 0.5%)]. In a case, where two agents draw up swap through direct contract, this always be the case. More realistically, agents will use financial intermediaries to draw up swap contracts. Hence, the total gain will be split three ways. In this case, 0.5% will be divided 3 ways between the bank, Agent 1, and Agent 2. Facility margin is earned by the bank.

Fee per annum

Swap Counterparty

Banks
Swap Default Payment

Loans to customers

In the pure credit swap, the bank pays a fixed fee or payment to the swap counterparty. If the banks loan or loans do not default, it will receive nothing back from the CDS counterparty. If the bank or loans default, the CDS counterparty will cover the default loss by making a default payment. This default payment is equal to the par value of the original loan minus the secondary market value of the default loan. For example, the par value of the original loan is $100 and the market value of the same loan is $40. In this case, the swap counterparty pays $60 ($100-$40) to the bank. Thus, a pure credit swap is like buying credit insurance and/pr a multi-period credit option. In a CDS, the protection seller agrees to compensate the protection buyer upon the following occurrences. The occurrences must be bankruptcy (corporate) /moratorium (sovereign), repudiation, failure to pay, obligation acceleration/default, and restructuring. In return, the protection seller charges a fee that is normally expressed in basis point per notional amount. Although premium payment for default protection may be paid as up-front fee for short-dated transactions, the it is generally made periodically: annually, semiannually, quarterly, or monthly. The most common payment frequency is quarterly.

CMOs can be created either by packaging and securitising mortgage loans, or by placing existing pass-through securities in a trust off the balance sheet. Issuing CMOs is often equivalent to double securitisation. CMO makes mortgage-backed securities more attractive to investors. CMO does this by repackaging cash flows from mortgages and pass-through securities in a different manner to attract different types of investors. Essentially, several types of securities are issued in order to attract investors with differing risk preferences. The process of CMOs is as follows. Originating bank packages and securities mortgage loans. Government agency, such as Ginnie Mae, guarantees the mortgage-backed bonds. Originating bank issues mortgage-backed bonds and then placed them in the trust as collateral. The trust issues these CMOs in three or more different classes. On one hand, pass-through security gives each investor a pro rate share of any promised and prepared cash flows on a mortgage pool. On the other hand, CMO is multiclass pass-through with a number of different bondholder classes or tranches. Specifically, each bondholder class has a different guaranteed coupon. Cash flows are prioritised to the lower-risk securities within the hierarchy of assets. For example, if only two types of securities (junior and senior) are issued, the junior securities take on most of the risk. Suppose someone pays off the mortgage loan early. In this case, the cash flow from early mortgage loan prepayment is used to retire senior securities outstanding principal. Therefore, the senior bonds retire since the principal is fully paid. The junior class prepayment are protected for a period of time. Trustee continues to pay to junior bondholders until junior class bonds retire.

CMOs can have up to 17 different classes. There are five known classes of CMOs: Class A, B, C, Z, and R. Class A CMOs have the shortest average life with a minimum of prepayment protection. Therefore, they are great interest to investors seeking shortduration mortgage-backed assets. It is because investors want to reduce the duration of their mortgage-related asset portfolios. Class B CMOs have some prepayment and expected durations of five to seven years depending on the level of interest rates. Pension funds and life insurance companies primarily purchases these bonds. Class C CMOs are highly attractive to insurance companies and pension funds because of their long expected durations. Insurance companies and pension funds invest them to match their long-term duration liabilities. Class C CMOs are particularly more attractive than regular pass-through. This is because Class C CMOs offer highest (but imperfect) degree of prepayment protection, compared to regular pass-through with no prepayment protection.

Class Z CMOs has a stated coupon such as 10 percent. In addition, they accrue interest for bond holders on a monthly basis at this rate. The trustee does not pay interest, however, until all other classes of CMOs are fully retired. When the other classes have been retired, the Zclass bondholders receives the promised coupon and principal payments plus accrued interest payment. Thus, Class Z CMOs has characteristics of both zero-coupon bond no coupon payments for a long period- and a regular bond. Class R CMOs is the residual and high risk investment class. Suppose all other bonds classes have been retired. The holders of Class R CMOs have the right to the overcollateralization and reinvestment income on cash flow in the CMO trust. Reinvestment income is the result of trustee reinvesting proceeds from the sale of bonds in period prior to paying interest on the CMOs. Class R CMOs often have negative duration. This is because the value of the return in this CMOs increase with a rise in interest rate. Thus, Class R CMOs are potentially attractive to banks that seek to hedge their regular bond and fixed-income portfolios.

Good B X 5 Y 3 C 3 2 D 1 5 M N

U0 Good A

The curve in the above diagram is called indifference curve. Ux, where x = 0,1,2,, is known as utility. there are four fundamental assumptions of indifference curve. Completeness: Consumers preferences are assumed to be complete. This means that they have two goods or more for their own preferences. If there is only one good they prefer, consumer theory is violated! It is because we cannot compare with only one good. Transitivity: Preferences are transitive. This means that if there are three goods A, B, C - for a person, the person prefer A to B to C: he prefers A to B, he also prefers B to C, and he also prefers A to C. However, if he prefers A to B, B to C, and C to A, then it is not transitivity. This violates the consumer theory. Nonsatiation: It means that more is better than less. In other words, you prefers 4 good A and 4 good B than 2 good A and 2 good B. Diminishing Marginal Rate of Substitution: Marginal rate of substitution (MRS) is the slope of the indifference curve. Mathematically, MRS = -Good B/Good A. This means that you are willing to give up good B for more good A. Diminishing marginal rate of substitution implies that if you move along the indifference curve, U0, MRS becomes smaller and smaller: From X to Y, -5/3 = -1.67 -> C to D, -3/2 = -1.5 -> M to N = -1/5 -0.2

Good B

5 4 2 U1 U0 5 Good A U2

If you move up from U0 to U1, you are maximising utility or welfare. The rationale is that, if you like good B more than good A, holding good A constant, you increase your consumption of good B.

Utility theory is a concept used in economics to model human behaviour using mathematical functions called utility functions. These functions can be defined over money in terms of financial instruments. If an individual, through some investment choice, ends up with a final cash balance of w, his utility can be said such that: u(w), where u is the utility function. If w is a random variable, his utility can be measured by expected utility. In general, expected utility is not equal to the utility of his expected cash balance, such that: E(u(w)) u(E(w)). Utility theory can be thought of as a representation of preferences over outcomes. Specifically, utility theory show that when our preferences are sufficiently structured (or rational), we can represent these by a utility function. For example, suppose an individual can choose first between two lotteries. Lottery A pays $1m with 50% probability and 0 with 50% probability. Lottery B pays $4m with 25% probability and 0 with 75% probability. Then, the agent is asked to choose between a lottery C paying $1m for sure and a lottery D paying $4m with 25% probability, $1m with 50% probability and 0 with 25% probability. The interdependence property states that if the individual choose A before B then he also should choose C before D.

Risk aversion indicates a property of preferences where agents are unwilling to take on actuarially fair risk. For example, tossing a coin with heads-you-win and tails-you-lose leads to zero expected gain. Risk aversion can be modelled by concave utility functions.
Expected Utility

Wealth

These functions put less weight on gains than on losses, so that the expected utility of a risky outcome is always less that the utility of the expected outcomes. This means that marginal utility diminishes as wealth rises

Expected Utility

WEALTH

Expected Utility

WEALTH

Risk aversion is measured by risk aversion coefficient, formally derived from the utility functions by the relationship. Suppose investor has a constant absolute risk aversion (CARA) utility, the utility function takes the form: U(x) = - exp(-x) (1) The first-order derivation of utility function measures the slope of the function at a given point, such that: U(x) = -exp(-px) (2) The second-order derivation of utility function measures the change in the slope, such that: U(x) = 2exp(-px) Divide equation (3) by equation (2):

Risk Aversion - U(x) = Coefficient U(x)

= -

2exp(-px) -exp(-px)

(4)

Risk aversion coefficient measures the curvature. Given equation (4), risk aversion coefficient is negative, which confirms the concave-shaped slope. If the utility function is linear, the risk aversion coefficient is zero, indicating risk neutral preferences. The larger the swings in rates of return, the greater discrepancy between the arithmetic and geometric averages, that is between the compound rate earned over the sample period and the average of the annual returns. If the returns come from a normal distribution, the difference is exactly equals half the variance of the distribution. If assets are normally distributed, the expected utility function can be written as:

E(u(x)) = E(x) -

var(x) 2

(5)

where E(x) is expected return; is the investors risk aversion. To use equation (5), the rates of return must be expressed as decimals rather than percentages. Equation (5) is consistent with the notion that utility is enhanced by high expected returns and diminished by high risk. The greater the premium is, the greater the risk aversion of the investor must be.

Suppose a CARA investor is indifferent between holding large-company stocks and longterm US treasury bills over a long period of time. The arithmetic average return and standard deviations of large-company stocks are 12.04% and 20.55%. The arithmetic average return and standard deviations of long-term US treasury bills are 5.68% and 8.24%. The following expressed must hold:

0.1204 -

0.20552 = 0.0568 2

0.1204 -

0.0422 = 0.0568 2

0.08242 2

0.0068 2

0.0422 0.1204 - 0.0568 = 2

0.0354 0.0636 = 2

0.0068 2

0.0636 x 2 = x 0.0354
0.1272 = x 0.0354

0.1272 0.0354 =
= 4 (round off to whole number)

Explain why risk-averse individuals are willing to pay an insurance premium to remove risk?
Expected Utility

EU0

W-L

W-R W-pL

Wealth

Assume that an individual has initial wealth W and suffers a loss L with probability p. The maximum premium R he or she will pay makes himself or herself just to be indifferent between taking out insurance and not taking out insurance. Without insurance, he or she gets expected utility, such that EU0 = [p x U(W-L)] + [(1-p) x U(W)] The expected utility without insurance is a convex combination of U(W) and U(W-L); the exact position is determined by p so that EU0 can be read off the graph just above W-pL. The utility level corresponds to a certain prospect W-R(or certainty equivalent[CE]) which has to be less than W-pL, so that R>pL. If risk-averse individual is offered actuarially fair insurance (premium P equal expected loss pL), he will insure

Asset pricing models predicts that the expected return on assets is linked to the risk of holding these assets. Overall, the empirical evidence supports this prediction. Based on the US experience from 1926 to 2002, there is a clear relationship between risk and return among asset classes. The more risk the investor takes on, the greater the compensation is in terms of expected return. This can be explained by risk aversion, which implies that investors are unwilling to take actuarially fair risk.

Prescott and Mehra (1985) observed that historical excess returns on risky assets in the US are too large to be consistent with economic theory and reasonable levels of risk aversion. This observation has come to be known as the equity premium puzzle To see why it is equity premium puzzle, consider the following example. Suppose a person, who invested $1,000 in Treasury bills on 31 December 1925. He or she kept it in safe Treasury bills until 31 December 1995. The Treasury bills investment would be worth $12,720. Suppose if he or she invested $1,000 in the stock market on the same day in 1925. By 31 December 1995, the equity investment would be worth $842,000, which was 66 times the amount of Treasury bills investment. This equity investment would have survived two large stock market crashes in 1929 and 1987. The return on equity is greater than the return on the bonds due to higher risk associated with stock. But, the difference between returns on equity and bonds are strikingly large to be explained by standard economic models.

They found that a reasonable estimate for the risk aversion coefficient is between 30 and 40. They concluded that this estimation is way too high to be reasonable. To understand why it is way too high, consider the following analogy. Suppose you have a gamble where you face a 50 percent chance of doubling your wealth and a 50 percent chance of halving your wealth. You will be willing to pay 49 percent of your wealth to avoid the 50 percent chance of having your wealth. Suppose that your current wealth is 100. You will be indifferent between paying 49 and keeping 51 for sure, and a gamble, where there is a half chance of receiving 50 and half chance of receiving 200. In practice, it will be difficult to find anybody not preferring the gamble in this case.

Siegel and Thaler (1997) pointed out that Mehra and Prescott might have sampled data that were special in two senses. First, time period might be too short. This suggests a possibility that the period is too special to make safe inferences about the implied risk aversion coefficient. Siegel extended the US data on real stocks and bonds all the way back to 1802. Siegel found that real returns in the short-term fixed income market have fallen dramatically over time. In contrast, the real return on equity has remained remarkably constant. The excess return on equity has been 5.3 percent per year, 1.3 percentage points less than that reported by Mehra and Prescott (1985). This will reduce the magnitude of the risk aversion coefficient. But, it is doubtful that the puzzle will be completely solved.

Second, Siegel and Thaler pointed out that time series of estimated US data were too long. This means that the equity risk premium is necessarily distorted by the fact that it is calculated for a survivor. The long-surviving data series would tend to be healthier and show average returns that are higher than the perceived expected returns at historical points in time. Investors might reasonably worried about the risk of a crisis or catastrophe that can wipe out the entire market overnight. Among 36 stock exchanges that operated at the early 1900s, more than one-half of them had significant interruptions or were abolished outright. On this argument, the riskiness of equities is understated by estimates relying on U.S. existing data. This is because the data do not show the catastrophe that might have occurred in US. Survivorship bias might be a source of some errors in the estimation of the risk aversion coefficient. But, it is unclear how much it contributes.

Q2a, Q2b, and Q2c ZA 2006 Q4a and Q8b ZA 2010 Q2a, Q2b and Q2c ZB 2006 Q5c ZB 2007 Q5a and Q6c ZB 2008 Q5c and Q7a ZB 2009 Q7c and Q8c ZB 2010