Multiple-Trigger Catastrophe Bond Pricing Model and Its Simulation Using Numerical Methods

Abstract

Investor interest in single-trigger catastrophe bonds (STCB) has the potential to decline in the future. It is triggered by the increasing trend of global catastrophe loss and intensity every year, which increases the probability that a claim of STCB will occur. To increase investor interest again, the issuance of multiple-trigger catastrophe bonds (MTCB) can be one solution. However, to issue MTCB, its pricing is more complex because it involves more factors than STCB. Therefore, this study aims to design a simple MTCB pricing model. The claim trigger indices used are actual loss and fatality. Then, a nonhomogeneous compound Poisson process is used to model actual losses and fatalities aggregate to consider catastrophe intensity. In addition, this study proposes numerical methods, namely the continuous distribution approximation method and the Nuel recursive method, to facilitate the application of the model. Finally, an analysis of the effect of catastrophe intensity and other factors on MTCB prices is also presented. This study is expected to help special-purpose vehicles as MTCB issuers in MTCB pricing.

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.…”

“…This transforms the non-stationary series into a stationary one, which can be modeled using an ARMA process. The ARMA model for the intensity of annual rainstorms can be stated as follows 12 :…”

“…Although such industry loss trigger mechanisms can completely eliminate basis risk for insurers, the moral hazard is very high, since insurers may exaggerate losses in their loss statistics for their own benefit, creating a significant information asymmetry with capital market investors 11 . Additionally, as argued by Ibrahim et al 12 , investors' interest in single-event triggered catastrophe bonds is likely to decline in the future, since the global trend of increasing year-on-year disaster losses and intensity may increase the risk of catastrophe bond claims. Thus, issuing multi-trigger catastrophe bonds could be a solution using both industry loss indices and physical parameters as triggering conditions 6,13 .…”

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

“…Again, this nominal figure did not sufficiently cover the actual losses incurred. Thus, an innovative new mechanism must be developed to replace the traditional earthquake insurance mechanism [12][13][14].…”

“…The most successful financial instruments in EILS are bonds [19][20][21]. Compared to other financial instruments, bonds can raise significant funds quickly; however, they also involve moderate levels of risk [14]. This mechanism is known as the earthquake catastrophe bond (ECB).…”