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The valuation of nature-linked bonds with exchange rate risk

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  • Patrice Poncet
  • Victor Vaugirard

Abstract

This paper develops an arbitrage approach to pricing insurance bonds that bear currency risk. Bondholders are shown to have a short position on path-dependent digital options written on risk-tracking indices. It implements the technique of forward-neutral change of numeraire and comes down to computing first-passage-time distributions of drifted Brownian motions. We derive closed-form formulas or perform simulations depending on whether interest rates are deterministic or stochastic. Along the way, we evaluate outside-barrier currency call options. Then this research studies the effects of both nature risk and exchange rate uncertainty and shows that the former is more significant than the latter. Copyright Academy of Economics and Finance 2001

Suggested Citation

  • Patrice Poncet & Victor Vaugirard, 2001. "The valuation of nature-linked bonds with exchange rate risk," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 25(3), pages 293-307, September.
    • Handle: RePEc:spr:jecfin:v:25:y:2001:i:3:p:293-307
    DOI: 10.1007/BF02745890
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    References listed on IDEAS

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    1. Andreas Müller & Marcel Grandi, 2000. "Weather Derivatives: A Risk Management Tool for Weather-sensitive Industries," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 25(2), pages 273-287, April.
    2. Christensen, Claus Vorm & Schmidli, Hanspeter, 2000. "Pricing catastrophe insurance products based on actually reported claims," Insurance: Mathematics and Economics, Elsevier, vol. 27(2), pages 189-200, October.
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    Cited by:

    1. Lai, Van Son & Parcollet, Mathieu & Lamond, Bernard F., 2014. "The valuation of catastrophe bonds with exposure to currency exchange risk," International Review of Financial Analysis, Elsevier, vol. 33(C), pages 243-252.
    2. Victor Vaugirard, 2003. "Valuing catastrophe bonds by Monte Carlo simulations," Applied Mathematical Finance, Taylor & Francis Journals, vol. 10(1), pages 75-90.

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