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

Longfei Wei; Lu Liu; Jialong Hou; Longfei Wei; Lu Liu; Jialong Hou

doi:10.3934/QFE.2022010

Quantitative Finance and Economics

2022, Volume 6, Issue 2: 223-243. doi: 10.3934/QFE.2022010

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Research article

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

1.
School of Finance, Dongbei University of Finance and Economics, Dalian 116025, China
2.
Department of Electrical and Computer Engineering, University of Florida, Gainesville, Florida 32603, USA

Received: 26 February 2022 Revised: 06 May 2022 Accepted: 10 May 2022 Published: 17 May 2022
JEL Codes: G15, G22

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, market interest rate and dependence of trigger indicators, and positively correlated with trigger level and coupon rate. This study can be used as a reference for formulating reasonable CAT bond pricing strategies.
- catastrophe bonds,
- hybrid trigger mechanism,
- Archimedean copula,
- extreme value theory,
- stochastic interest rates
Citation: Longfei Wei, Lu Liu, Jialong Hou. Pricing hybrid-triggered catastrophe bonds based on copula-EVT model[J]. Quantitative Finance and Economics, 2022, 6(2): 223-243. doi: 10.3934/QFE.2022010

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Abstract

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, market interest rate and dependence of trigger indicators, and positively correlated with trigger level and coupon rate. This study can be used as a reference for formulating reasonable CAT bond pricing strategies.

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