Integrating ENSO Climate Risk into Flood Catastrophe Bonds for Disaster Risk Financing: An Asset-Pricing Framework

Empirical evidence shows that the El Niño-Southern Oscillation (ENSO) influences the frequency–damage relationship for floods. However, ENSO is generally not incorporated into indemnity-trigger modeling of Flood Catastrophe Bonds (FCBs), resulting in an incomplete representation of claim events. Therefore, this study aims to develop an FCB pricing model that incorporates ENSO as an external systematic risk factor affecting the indemnity trigger. The trigger is formulated as a doubly stochastic compound Poisson process, with its intensity modeled as an autoregressive integrated moving-average with exogenous variables. Bond prices are then derived by integrating the trigger process with the Cox-Ingersoll-Ross model under an arbitrage-free risk-neutral framework. To obtain stable numerical solutions, a Monte Carlo-based algorithm is also developed. Numerical simulations using data from Bandung Regency, Indonesia, show stable estimates under the relative Monte Carlo standard error measure. Then, incorporating ENSO empirically improves flood-intensity forecasting accuracy, as indicated by lower MAPE, MAE, RMSE, and Theil’s U. It also produces statistically significant price differences across all common maturities. This study advances the theoretical and practical pricing of FCBs by directly linking climate-driven flood intensity to indemnity triggers, equipping practitioners to quantify risk better and to set sustainable disaster risk financing, particularly in ENSO-affected regions.