CAT BOND PRICING UNDER A PRODUCT PROBABILITY MEASURE WITH POT RISK CHARACTERIZATION

Qihe Tang; Zhongyi Yuan

doi:10.1017/asb.2019.11

CAT BOND PRICING UNDER A PRODUCT PROBABILITY MEASURE WITH POT RISK CHARACTERIZATION

Astin Bulletin ◽

10.1017/asb.2019.11 ◽

2019 ◽

Vol 49 (2) ◽

pp. 457-490 ◽

Cited By ~ 1

Author(s):

Qihe Tang ◽

Zhongyi Yuan

Keyword(s):

Probability Measure ◽

Interest Rate Risk ◽

Bond Market ◽

Risk Characterization ◽

Peaks Over Threshold ◽

Product Pricing ◽

Cat Bonds ◽

Pricing Measure ◽

Earthquake Data ◽

Pricing Framework

AbstractFrequent large losses from recent catastrophes have caused great concerns among insurers/reinsurers, who then turn to seek mitigations of such catastrophe risks by issuing catastrophe (CAT) bonds and thereby transferring the risks to the bond market. Whereas, the pricing of CAT bonds remains a challenging task, mainly due to the facts that the CAT bond market is incomplete and that the pricing usually requires knowledge about the tail of the risks. In this paper, we propose a general pricing framework based on a product pricing measure, which combines a distorted probability measure that prices the catastrophe risks underlying the CAT bond with a risk-neutral probability measure that prices interest rate risk. We also demonstrate the use of the peaks over threshold (POT) method to uncover the tail risk. Finally, we conduct case studies using Mexico and California earthquake data to demonstrate the applicability of our pricing framework.

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Global Catastrophe Bond Market and the Prospects of Its Formation in the Russian Federation

Financial Journal ◽

10.31107/2075-1990-2021-1-75-92 ◽

2021 ◽

Vol 13 (1) ◽

pp. 75-92

Author(s):

Natalya A. Khutorova ◽

Keyword(s):

Russian Federation ◽

Global Market ◽

Bond Market ◽

Investment Fund ◽

Socially Responsible ◽

Catastrophe Bonds ◽

Catastrophe Risk ◽

Cat Bonds ◽

Socially Responsible Investments ◽

The Russian Federation

The article is devoted to the development of instruments for catastrophe risk financing. The state of the global market for disaster risk financing is analyzed in order to identify the main development trends and the possibilities of using conceptual approaches in the Russian practice of the financial market. It is proven that the development of the catastrophe bond market has prospects in conditions of permanent instability, since catastrophe bonds are unique and highly attractive due to the lack of correlation with macroeconomic events. It is suggested that the instruments of catastrophe risk financing can be considered in the context of the development of sustainable finance. The paper identifies the main problems slowing down the development of the Russian catastrophe bond market, and formulates proposals aimed at developing the market for insurance-linked securities (ILS) in the Russian Federation. Pilot CAT bonds emission prospectuses should be based on structured bonds, with elements of a subordinated bond. There is a need to introduce into the Russian legal field a term defining ILS as a category. It is proposed to register special purpose vehicles (SPVs) and catastrophe funds in Russian offshores. The Russian analogue of catastrophe funds should be a closed-end investment fund with high funding for qualified investors. It is proposed to update the formula for calculating the creation of and the procedure for using reserve funds, in particular with the use of catastrophe risk financing tools. A pilot issue of CAT bonds is proposed to be conducted on behalf of VEB.RF, as bonds sponsoring regions exposed to high natural risks. In the process of developing socially responsible investor practice and tools for socially responsible investments, it is suggested to establish a Russian “Green Index” and to create green ETFs in Russia. Due diligence (DD) approaches are recommended for decisions on issuing catastrophe bonds.

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Debt Fundamentals and Indices

Debt Markets and Investments ◽

10.1093/oso/9780190877439.003.0002 ◽

2019 ◽

pp. 23-40

Author(s):

Ryan J. Dodge ◽

Steven T. Petra ◽

Andrew C. Spieler

Keyword(s):

Risk Factors ◽

Interest Rate ◽

Local Governments ◽

Interest Rate Risk ◽

Bond Market ◽

Fixed Income ◽

Public And Private ◽

Risk Return ◽

Private Placements ◽

Bond Indices

This chapter serves as an introduction to debt obligations and securities and in particular bonds and related fixed income instruments. The chapter discusses the size of the bond market relative to other traditional asset classes as well as describing different types of debt instruments. The relatively large par value of bonds and structured payments affects the issuance, trading, and ratings processes. The unique structure and risk-return profile of fixed income instruments can be useful for investors to hold in their portfolios. Bonds are obligations of federal and local governments, corporations, and other issuers and are issued via auctions and public and private placements. The fundamental risk factors including interest rate risk, credit risk, and option risk are summarized. Finally, the chapter concludes with a discussion about the purpose and uses of bond indices with a focus on some challenges involved in their construction.

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The Three-Factor Hedging Strategy for Mortgage Pass-Through Securities: Empirical Evidence

The Journal of Fixed Income ◽

10.3905/jfi.2018.1.066 ◽

2019 ◽

Keyword(s):

Interest Rate ◽

Interest Rate Risk ◽

Bond Market ◽

The Other ◽

Hedging Strategy ◽

Hedging Strategies ◽

Rate Risk ◽

Pass Through ◽

Investment Grade ◽

Three Factor

The mortgage pass-through securities sector of the investment-grade bond market is attractive to institutional investors seeking to outperform a bond index without taking a view on credit risk. Market participants view this sector as being less price efficient than the other investment-grade bonds sectors, offering opportunities within the sector to take contrary positions relative to prevailing prices, particularly with respect to future prepayments. In executing a relative value strategy to enhance returns in this sector, portfolio managers must be able to remove interest rate risk. Unlike hedging interest rate risk in the other sectors of the investment-grade bond market, the cash flow structure of mortgage pass-throughs is such that there is interest rate exposure, via prepayment rates, due to a change in the term structure of interest rate. Both academics and practitioners have proposed several strategies for hedging interest rate risk. In this article, the authors evaluate a three-factor hedging strategy for agency pass-throughs, comparing the performance of this strategy to both the single-factor and two-factor hedging strategies. Their analysis finds that under certain conditions the three-factor hedging strategy outperforms both the one- or two-factor hedging strategy.

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