What is a Wang Transform?
A risk-adjustment methodology that converts physical (real-world) loss probabilities into risk-adjusted probabilities for pricing.
Wang Transform
A risk-adjustment methodology that converts physical (real-world) loss probabilities into risk-adjusted probabilities for pricing.
How it works in practice
A catastrophe model estimates a 2% annual probability of loss for a cat bond. Using the Wang Transform, the pricing actuary distorts this probability upward to 3.1% to account for risk aversion and parameter uncertainty. The distorted probability is then used to calculate the required spread. The result is a coupon higher than what pure expected loss alone would imply, reflecting the market price of bearing tail risk.
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