Pricing catastrophe swaps with default risk and stochastic interest rates

Lo, Chien-Ling; Chang, Carolyn W.; Lee, Jin‐Ping; Yu, Min‐Teh

doi:10.1016/j.pacfin.2020.101314

Cited by 5 publications

(4 citation statements)

References 25 publications

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“…The maturities of CAT bonds are uniquely random because the time of a CAT event is uncertain. In order to resolve the random maturity issue, Chang et al (2020) propose a modeling methodology to price hurricane bonds at the nexus of atmospheric science and finance by integrating hurricane risk modeling and option pricing modeling. For the empirical analysis of CAT bond prices, Braun (2016) introduces the following econometric pricing model for CAT bonds in the primary market and confirms that the main drivers of CAT bond spread upon issuance include the EL calculated by CAT modeling companies, covered territory, sponsor, reinsurance cycle and comparably rated corporate bond spreads.…”

Section: Cat Bondmentioning

confidence: 99%

“…However, the valuation model of Braun ( 2011) assumes constant interest rates and no counterparty risk. Improving upon the pricing approach of Braun (2011), Lo et al (2020) incorporate interest rate risk, counterparty default risk, basis risk and trigger type to develop a dynamic structural framework to price CAT swaps. The results of the Monte Carlo simulation show that stochastic interest rates have significant impacts on three-year and five-year contracts of CAT swaps and one-year contracts of CAT swaps that are exposed to severe basis risk.…”

Section: Cat Swapmentioning

confidence: 99%

“…In this section, we follow the works of Yu (2002, 2007), Lo et al (2013) and Lo et al (2020) to illustrate the framework and procedures in pricing CAT-linked securities under Merton's structural framework. In addition to deriving the values of CAT-linked securities, this approach can explicitly investigate how the (re)insurer's financial position and debt structure affect values of these securities.…”

Section: Valuation Of Catastrophe-linked Securitiesmentioning

confidence: 99%

“…Some popular CAT-linked securities include CAT insurance futures and options, CAT bonds, CAT equity puts, CAT swaps and contingent convertible CAT bonds. We follow the structural approach of Yu (2002, 2007), Lo et al (2013), and Lo et al (2020) to illustrate the framework and procedures in pricing CAT-linked securities. Among these securitized instruments, CAT bonds continue to grow and have become the most successful securitized CAT risk-transfer instrument up to now.…”

Section: Introductionmentioning

confidence: 99%

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Catastrophe risk, reinsurance and securitized risk-transfer solutions: a review

Zhao

Lee

2021

CFRI

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PurposeCatastrophe (CAT) events associated with natural catastrophes and man-made disasters cause profound impacts on the insurance industry. This research thus reviews the impact of CAT risk on the insurance industry and how traditional reinsurance and securitized risk-transfer instruments are used for managing CAT risk.Design/methodology/approachThis research reviews the impact of CAT risk on the insurance industry and how traditional reinsurance and securitized risk-transfer instruments are used for managing CAT risk. Apart from many negative influences, CAT events can increase the net revenue of the insurance industry around CAT events and improve insurance demand over the post-CAT periods. The underwriting cycle of reinsurance causes inefficiencies in transferring CAT risks. Securitized risk-transfer instruments resolve some inefficiencies of the reinsurance market, but are subject to moral hazard, basis risk, credit risk, regulatory uncertainty, etc. The authors introduce some popular securitized solutions and use Merton's structural framework to demonstrate how to value these CAT-linked securities. The hybrid solutions by combining reinsurance with securitized CAT instruments are expected to offer promising applications for CAT risk management.FindingsThe authors introduce some popular securitized solutions and use Merton's structural framework to demonstrate how to value these CAT-linked securities. The hybrid solutions by combining reinsurance with securitized CAT instruments are expected to offer promising applications for CAT risk management.Originality/valueThis research reviews a broad array of impacts of CAT risks on the (re)insurance industry. CAT events challenge (re)insurance capacity and influence insurers' supply decisions and reconstruction costs in the aftermath of catastrophes. While losses from natural catastrophes are the primary threat to property–casualty insurers, the mortality risk posed by influenza pandemics is a leading CAT risk for life insurers. At the same time, natural catastrophes and man-made disasters cause distinct impacts on (re)insures. Man-made disasters can increase the correlation between insurance stocks and the overall market, and natural catastrophes reduce the above correlation. It should be noted that huge CAT losses can also improve (re)insurance demand during the postevent period and thus bring long-term effects to the (re)insurance industry.

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Section: Cat Bondmentioning

confidence: 99%

Section: Cat Swapmentioning

confidence: 99%

Section: Valuation Of Catastrophe-linked Securitiesmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

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Catastrophe risk, reinsurance and securitized risk-transfer solutions: a review

Zhao

Lee

2021

CFRI

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Do Sovereign Catastrophe Bonds Improve Fiscal Resilience? An Application of Synthetic Control Method to Mexico

Maran¹

2023

EconDisCliCha

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Natural disasters exert a signi cant impact on government nances. Catastrophe bonds (CAT bonds) constitute risk-transfer instruments that could help governments improve their scal resilience when catastrophic events occur. However, given the very limited issuance of sovereign CAT bonds so far, their actual impact on scal resilience is di cult to quantify. There is no literature on this topic currently available. I attempt to ll this gap and assess the impact of CAT bond payouts on the scal balance of the Mexican government using the synthetic control method. As an early adopter and repeated issuer of sovereign CAT bonds since 2006, Mexico received its rst CAT bond payout in 2017. The payout was triggered by a high-magnitude earthquake that stroke the country in September 2017, with an estimated impact of 0.24% of Mexico's gross domestic product (GDP). I identify 12countries that experienced natural disasters with a similar impact on GDP in 2017, but which unlike Mexico have not received a CAT bond payout that year. I then compare post-2017 scal balances for Mexico with a synthetic control unit that combines the characteristics of the 12 similar but untreated countries, while controlling for other factors that could have had an impact on this scal variable. I nd a positive impact of the 2017 CAT bond payout on the evolution of Mexico's scal balance compared to its synthetic control unit.

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Pricing Hurricane Bonds Using a Physically Based Option Pricing Approach

Chang

2020

North American Actuarial Journal

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Pricing catastrophe swaps with default risk and stochastic interest rates

Cited by 5 publications

References 25 publications

Catastrophe risk, reinsurance and securitized risk-transfer solutions: a review

Catastrophe risk, reinsurance and securitized risk-transfer solutions: a review

Do Sovereign Catastrophe Bonds Improve Fiscal Resilience? An Application of Synthetic Control Method to Mexico

Pricing Hurricane Bonds Using a Physically Based Option Pricing Approach

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