Pricing Multi-event Triggered Catastrophe Bonds Based on Copula-POT Model

TL;DR

This paper develops a novel pricing framework for multi-event catastrophe bonds using copula-POT models, addressing dependence and tail risks to enhance risk transfer and attract investors.

Contribution

Introduces a hybrid trigger mechanism and copula-based dependence modeling for pricing multi-event catastrophe bonds with extreme risks.

Findings

The pricing model effectively captures dependence among multiple natural disaster events.

Monte Carlo simulations demonstrate sensitivity of bond prices to trigger levels and catastrophe intensity.

The framework improves risk assessment and bond attractiveness in catastrophe insurance markets.

Abstract

The constantly expanding frequency and loss affected by natural disasters pose a severe challenge to the traditional catastrophe insurance market. This paper aims to develop an innovative framework of pricing catastrophic bonds triggered by multiple events with extreme dependence structure. Given the low contingency of the bond's cash flows and high return, the multiple-event CAT bond may successfully transfer the catastrophe risk to the big financial markets meeting the diversification of capital allocations for most potential investors. The designed hybrid trigger mechanism helps reduce moral hazard and improve bond attractiveness with CIR stochastic rate, displaying the co-movement of the wiped-off coupon, payout principal, the occurrence and intensity of the natural disaster involved. As different triggered indexes of multiple-event catastrophic bonds are heavy-tailed with a variety of dependence relationship, nested Archimedean copulas are introduced with marginal distributions modeled by POT-GP distribution for excess data and common parametric models for moderate risks. To illustrate our theoretical pricing framework, we consider a three-event rainstorm CAT bond triggered by catastrophic property losses, in China during 2006--2020. Monte Carlo simulations are conducted for the sensitivity analysis of the rainstorm CAT bond price is also in trigger attachment levels, maturity date, catastrophe intensity, and numbers of trigger indicators.