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

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.

Keywords

• catastrophe bonds
• hybrid trigger mechanism
• archimedean copula
• extreme value theory
• stochastic interest rates