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CAT BOND PRICING UNDER A PRODUCT PROBABILITY MEASURE WITH POT RISK CHARACTERIZATION

Published online by Cambridge University Press:  24 April 2019

Qihe Tang  and
Zhongyi Yuan
Qihe Tang
Affiliation:
School of Risk and Actuarial StudiesUNSW Business SchoolUNSWSydney, NSW 2052, Australia E-mail: [email protected] Department of Statistics and Actuarial ScienceUniversity of IowaCollege of Liberal Arts & SciencesIowa City, IA 52242, USA E-mail: [email protected]
Zhongyi Yuan*
Affiliation:
Department of Risk ManagementSmeal College of BusinessThe Pennsylvania State UniversityUniversity Park, PA 16802, USA E-mail: [email protected]
*
E-mail: [email protected]
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Abstract

Frequent large losses from recent catastrophes have caused great concerns among insurers/reinsurers, who then turn to seek mitigations of such catastrophe risks by issuing catastrophe (CAT) bonds and thereby transferring the risks to the bond market. Whereas, the pricing of CAT bonds remains a challenging task, mainly due to the facts that the CAT bond market is incomplete and that the pricing usually requires knowledge about the tail of the risks. In this paper, we propose a general pricing framework based on a product pricing measure, which combines a distorted probability measure that prices the catastrophe risks underlying the CAT bond with a risk-neutral probability measure that prices interest rate risk. We also demonstrate the use of the peaks over threshold (POT) method to uncover the tail risk. Finally, we conduct case studies using Mexico and California earthquake data to demonstrate the applicability of our pricing framework.

Keywords

CAT bonddistortionearthquakeextreme value theorygeneralized Pareto distributionpeaks over thresholdpricingproduct measure
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 49 , Issue 2 , May 2019 , pp. 457 - 490
Copyright
Copyright © Astin Bulletin 2019 

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