Question

consider a risk averse asset manager who holds a portfolio of commercial property worth £900 million. they estimate there is a 25 per cent chance the real estate market will worsen next year and the portfolio will be worth only £400 million. they also think there is a 75 per cent chance that property values will remain stable.

How much would this manager be willing to pay to insure his assets ?

Answer 1

Let's first estimate the likely profit/loss next year:

Loss of 500M with a 25% probability (900 - 400)

Gain of 0 with a 75% probability

So the expected gain / loss next year is:

0.25 * -500 + 0.75 * 0 = -125M

This risk averse manager would be willing to pay 125M to insure his assets.