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Indifference prices of structured catastrophe (CAT) bonds

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  • Egami, Masahiko
  • Young, Virginia R.

Abstract

We present a method for pricing structured CAT bonds based on utility indifference pricing. The CAT bond considered here is issued in two distinct notes called tranches, specifically senior and junior tranches each with its own payment schedule. Our contributions to the literature of CAT bond pricing are two-fold. First, we apply indifference pricing to structured CAT bonds. We find a price for the senior tranche as a relative indifference price, that is, relative to the price of the junior tranche. Alternatively, one could take the approach that the senior tranche is priced first and the price of the junior tranche is relative to that. Second, instead of simply supposing that the "not-issue-a-CAT-bond" strategy of the reinsurer is to do nothing, we suppose that the reinsurer reduces its risk by reinsuring proportionally less claims. We assume that the reinsurance claims follow a (Poisson) jump-diffusion process.

Suggested Citation

  • Egami, Masahiko & Young, Virginia R., 2008. "Indifference prices of structured catastrophe (CAT) bonds," Insurance: Mathematics and Economics, Elsevier, vol. 42(2), pages 771-778, April.
    • Handle: RePEc:eee:insuma:v:42:y:2008:i:2:p:771-778
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    References listed on IDEAS

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    1. Virginia R. Young, 2004. "Pricing In An Incomplete Market With An Affine Term Structure," Mathematical Finance, Wiley Blackwell, vol. 14(3), pages 359-381, July.
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    5. Samuel Cox & Hal Pedersen, 2000. "Catastrophe Risk Bonds," North American Actuarial Journal, Taylor & Francis Journals, vol. 4(4), pages 56-82.
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    2. Liu, Haibo, 2025. "Robust indifference valuation of catastrophe bonds," Insurance: Mathematics and Economics, Elsevier, vol. 122(C), pages 1-10.
    3. Junfei Chen & Guiyun Liu & Liu Yang & Quanxi Shao & Huimin Wang, 2013. "Pricing and Simulation for Extreme Flood Catastrophe Bonds," Water Resources Management: An International Journal, Published for the European Water Resources Association (EWRA), Springer;European Water Resources Association (EWRA), vol. 27(10), pages 3713-3725, August.
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    6. Alexander Braun, 2016. "Pricing in the Primary Market for Cat Bonds: New Empirical Evidence," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 83(4), pages 811-847, December.
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    8. Andreas Eichler & Gunther Leobacher & Michaela Szolgyenyi, 2016. "Utility Indifference Pricing of Insurance Catastrophe Derivatives," Papers 1607.01110, arXiv.org, revised May 2017.
    9. Eckhard Platen & David Taylor, 2016. "Loading Pricing of Catastrophe Bonds and Other Long-Dated, Insurance-Type Contracts," Papers 1610.09875, arXiv.org.
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    12. Braun, Alexander, 2011. "Pricing catastrophe swaps: A contingent claims approach," Insurance: Mathematics and Economics, Elsevier, vol. 49(3), pages 520-536.
    13. 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.
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    16. Denis-Alexandre Trottier & Van Son Lai & Anne-Sophie Charest, 2017. "CAT Bond Spreads Via HARA Utility and Nonparametric Tests," Working Papers 2017-002, Department of Research, Ipag Business School.
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