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Valuing catastrophe bonds by Monte Carlo simulations

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  • Victor Vaugirard
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    Abstract

    This paper reports fairly accurate simulations of insurance-linked securities within an arbitrage-free framework, while accounting for catastrophic events and allowing for stochastic interest rates. Assessing these contingent claims exhibits features of instability rooted in the discontinuity of the payoffs of binary options around their threshold, which is magnified by possible jumps in their underlying dynamics. The error made while simulating path-dependent digital options whose underlyings obey geometric Brownian motion is used to control the estimation of digital options whose underlyings follow jump-diffusion processes. Comparative statics results highlight the hump shape of the term structure of catbond yield spreads.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/1350486032000079741
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Applied Mathematical Finance.

    Volume (Year): 10 (2003)
    Issue (Month): 1 ()
    Pages: 75-90

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    Handle: RePEc:taf:apmtfi:v:10:y:2003:i:1:p:75-90

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    Related research

    Keywords: Catastrophe Bonds; Digital Options; Jump-diffusion Process; Mean-reverting Process; Variance Reduction;

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    Cited by:
    1. Bates, Samuel & Vaugirard, Victor, 2009. "Monetary Transmission Channels around the Subprime Crisis : The US Experience," Economics Papers from University Paris Dauphine 123456789/1483, Paris Dauphine University.
    2. 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.
    3. Lev Eppelbaum, 2013. "Non-stochastic long-term prediction model for US tornado level," Natural Hazards, International Society for the Prevention and Mitigation of Natural Hazards, vol. 69(3), pages 2269-2278, December.

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