Pricing hybrid-triggered catastrophe bonds based on copula-EVT model

Abstract

<abstract><p>This paper presents a hybrid-triggered catastrophe bond (CAT bond) pricing model. We take earthquake CAT bonds as an example for model construction and numerical analysis. According to the characteristics of earthquake disasters, we choose direct economic loss and magnitude as trigger indicators. The marginal distributions of the two trigger indicators are depicted using extreme value theory, and the joint distribution is established by using a copula function. Furthermore, we derive a multi-year hybrid-triggered CAT bond pricing formula under stochastic interest rates. The numerical experiments show that the bond price is negatively correlated with maturity, coupon rate and dependence of trigger indicators, and positively correlated with trigger level and market interest rate. This study can be used as a reference for formulating reasonable CAT bond pricing strategies.</p></abstract>

How to Price Catastrophe Bonds for Sustainable Earthquake Funding? A Systematic Review of the Pricing Framework

“…Thus, the full texts of eleven articles were reviewed. These were written by Romaniuk [40], Zimbidis et al [41], Shao et al [42], Gunardi and Setiawan [43], Tang and Yuan [44], Hofer et al [45], Kang et al [46], Wei et al [9], Mistry and Lombardi [47], Aghdam et al [48], and Anggraeni et al [49]. Primary information data for these eleven articles can be accessed at https://bit.ly/3Kwof5j (accessed on 24 March 2023).…”

“…As a result, between 1992 and 2000, many countries used traditional insurance mechanisms to obtain contingency costs for their earthquake responses. However, traditional earthquake insurance mechanisms are generally ineffective because the contingency costs are less significant than the actual losses [8,9]. For example, in 1992, Turkey used earthquake insurance to cope with an earthquake in Erzincan with a magnitude of 6.8 Mw [10].…”

Pricing Multi-event Triggered Catastrophe Bonds Based on Copula-POT Model

“…This model may provide certain reference for the pricing research and subsequent practical application of catastrophe bonds. Although the multi-event trigger mechanism involves more elements, and more complex processes and requires higher technical capabilities, the multiple-event triggered bonds receive increasing attraction due to its low moral hazard and trigger risk 12,20,21 . Meanwhile, it turns out that, the CAT bond price decreases in bond maturity period in the simulation, and it is negatively correlated with trigger level and positively correlated with catastrophe intensity.…”

“…(b) Our trigger mechanism in Eq. (2.4) with the hierarchical proportional coupon and principals paid out may attract more investors in comparison with the hybrid trigger mechanism given by Wei et al 21 . Since therein the current and future coupons will be paid out once one of the indicators is triggered and the principal at maturity will be completely wiped out once both indicators are triggered simultaneously.…”

“…This hybrid trigger mechanism can avoid basis risk and moral hazard with reduced triggering risk, attracting investors with a low risk appetite in the market. In addition to understanding the tail behavior of the marginal trigger indicators within the framework of extreme value theory [14][15][16][17][18] , the dependency among multiple trigger indicators need to be considered through copula approach [19][20][21] .…”