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Calibrating CAT Bonds for Mexican Earthquakes

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  • Wolfgang Karl Härdle
  • Brenda López Cabrera

Abstract

This article examines the calibration of a real parametric catastrophe bond (CAT bond) for earthquakes sponsored by the Mexican government, which is of a high interest as it delivers several policy‐relevant findings. The results demonstrate that a combination of reinsurance and CAT bond is optimal in the sense that it provides coverage for a lower cost and lower exposure at default than reinsurance itself. A hybrid CAT bond for earthquakes is also priced in order to reduce the basis and moral risk borne by the sponsor and to reflect the value of the loss by several variables.

Suggested Citation

  • Wolfgang Karl Härdle & Brenda López Cabrera, 2010. "Calibrating CAT Bonds for Mexican Earthquakes," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(3), pages 625-650, September.
    • Handle: RePEc:bla:jrinsu:v:77:y:2010:i:3:p:625-650
    DOI: 10.1111/j.1539-6975.2010.01355.x
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    References listed on IDEAS

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    Cited by:

    1. Nowak, Piotr & Romaniuk, Maciej, 2013. "Pricing and simulations of catastrophe bonds," Insurance: Mathematics and Economics, Elsevier, vol. 52(1), pages 18-28.
    2. Denis-Alexandre Trottier & Van Son Lai, 2017. "Reinsurance or CAT Bond? How to Optimally Combine Both," Working Papers 2017-003, Department of Research, Ipag Business School.
    3. Braun, Alexander, 2011. "Pricing catastrophe swaps: A contingent claims approach," Insurance: Mathematics and Economics, Elsevier, vol. 49(3), pages 520-536.
    4. Y. Esmaeelzade Aghdam & A. Neisy & A. Adl, 2024. "Simulating and Pricing CAT Bonds Using the Spectral Method Based on Chebyshev Basis," Computational Economics, Springer;Society for Computational Economics, vol. 63(1), pages 423-435, January.
    5. Shao, Jia & Papaioannou, Apostolos D. & Pantelous, Athanasios A., 2017. "Pricing and simulating catastrophe risk bonds in a Markov-dependent environment," Applied Mathematics and Computation, Elsevier, vol. 309(C), pages 68-84.
    6. Borensztein, Eduardo & Cavallo, Eduardo & Jeanne, Olivier, 2017. "The welfare gains from macro-insurance against natural disasters," Journal of Development Economics, Elsevier, vol. 124(C), pages 142-156.
    7. Zied Chaieb & Djibril Gueye, 2022. "Pricing zero-coupon CAT bonds using the enlargement of ltration theory: a general framework ," Post-Print hal-03745077, HAL.
    8. Truong, Chi & Trück, Stefan, 2016. "It’s not now or never: Implications of investment timing and risk aversion on climate adaptation to extreme events," European Journal of Operational Research, Elsevier, vol. 253(3), pages 856-868.
    9. Martin Eling, 2013. "Recent Research Developments Affecting Nonlife Insurance—The CAS Risk Premium Project 2011 Update," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 16(1), pages 35-46, March.
    10. Sukono & Hafizan Juahir & Riza Andrian Ibrahim & Moch Panji Agung Saputra & Yuyun Hidayat & Igif Gimin Prihanto, 2022. "Application of Compound Poisson Process in Pricing Catastrophe Bonds: A Systematic Literature Review," Mathematics, MDPI, vol. 10(15), pages 1-19, July.
    11. Giuricich, Mario Nicoló & Burnecki, Krzysztof, 2019. "Modelling of left-truncated heavy-tailed data with application to catastrophe bond pricing," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 525(C), pages 498-513.
    12. Alexis Louaas & Pierre Picard, 2014. "Optimal Insurance For Catastrophic Risk: Theory And Application To Nuclear Corporate Liability," Working Papers hal-01097897, HAL.
    13. Han-Bin KANG & Hsuling CHANG & Tsangyao CHANG, 2022. "Catastrophe Reinsurance Pricing -Modification of Dynamic Asset-Liability Management," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(4), pages 5-20, December.
    14. Volodymyr Perederiy, 2007. "Kombinierte Liquiditäts- und Solvenzkennzahlen und ein darauf basierendes Insolvenzprognosemodell für deutsche GmbHs," SFB 649 Discussion Papers SFB649DP2007-060, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    15. Krzysztof Burnecki & Mario Nicoló Giuricich, 2017. "Stable Weak Approximation at Work in Index-Linked Catastrophe Bond Pricing," Risks, MDPI, vol. 5(4), pages 1-19, December.
    16. Carolyn W. Chang & Jack S. K. Chang & Min‐Teh Yu & Yang Zhao, 2020. "Portfolio optimization in the catastrophe space," European Financial Management, European Financial Management Association, vol. 26(5), pages 1414-1448, November.
    17. Harsh K. Mistry & Domenico Lombardi, 2023. "A stochastic exposure model for seismic risk assessment and pricing of catastrophe bonds," Natural Hazards: Journal of the International Society for the Prevention and Mitigation of Natural Hazards, Springer;International Society for the Prevention and Mitigation of Natural Hazards, vol. 117(1), pages 803-829, May.
    18. Chang Carolyn W. & Feng Yalan, 2021. "Hurricane Bond Price Dependency on Underlying Hurricane Parameters," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 15(1), pages 1-21, January.
    19. Têtu Alexandre & Lai Van Son & Soumaré Issouf & Gendron Michel, 2015. "Hedging Flood Losses Using Cat Bonds," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 9(2), pages 149-184, July.
    20. Zied Chaieb & Djibril Gueye, 2022. "Pricing zero-coupon CAT bonds using the enlargement of ltration theory: a general framework," Papers 2208.02609, arXiv.org.
    21. Loretta Mastroeni & Alessandro Mazzoccoli & Maurizio Naldi, 2022. "Pricing Cat Bonds for Cloud Service Failures," JRFM, MDPI, vol. 15(10), pages 1-18, October.
    22. Lo, Chien-Ling & Lee, Jin-Ping & Yu, Min-Teh, 2013. "Valuation of insurers’ contingent capital with counterparty risk and price endogeneity," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5025-5035.
    23. Ben Ammar, Semir & Braun, Alexander & Eling, Martin, 2015. "Alternative Risk Transfer and Insurance-Linked Securities: Trends, Challenges and New Market Opportunities," I.VW HSG Schriftenreihe, University of St.Gallen, Institute of Insurance Economics (I.VW-HSG), volume 56, number 56.
    24. Ma, Zong-Gang & Ma, Chao-Qun, 2013. "Pricing catastrophe risk bonds: A mixed approximation method," Insurance: Mathematics and Economics, Elsevier, vol. 52(2), pages 243-254.
    25. Joanne Ho & Martin Odening, 2009. "Weather-based estimation of wildfire risk," SFB 649 Discussion Papers SFB649DP2009-032, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

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    More about this item

    JEL classification:

    • G19 - Financial Economics - - General Financial Markets - - - Other
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other
    • N26 - Economic History - - Financial Markets and Institutions - - - Latin America; Caribbean
    • N56 - Economic History - - Agriculture, Natural Resources, Environment and Extractive Industries - - - Latin America; Caribbean
    • Q29 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Other
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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