Pricing and Simulation for Extreme Flood Catastrophe Bonds

Abstract

With global climate change, the extreme flood disasters which are characterized with low frequency but huge economic losses occur more frequently. The management of the extreme flood disasters mainly depends on the administrative means of the governments at all levels in China. When the extreme flood occurs, the government financial aid and the social donation can be used to compensate the catastrophe losses, but these compensations account for only a small part of the catastrophe losses. Therefore, it is very urgent to disperse the flood catastrophe risk by social system. The catastrophe risk securitization bridges the capital market and the insurance market and can effectively transfer the catastrophe risk to the capital market. The catastrophe bond is an effective risk dispersion mode and the pricing of catastrophe bonds is the core issue of implementing catastrophe bonds. However, the research about the design and the pricing of extreme flood catastrophe bond is scarce. In this study, a kind of one-year extreme flood catastrophe bond was designed and simulations on the pricing according to the extreme flood data in China during 1961 to 2009 with quantitative analysis method were done, combined with the non-life insurance actuarial method and Wang-double-factor model. The results show that price of catastrophe bond is increasing with the increase of the value for triggering points and reducing when the ratio that corporation confiscates the capital and the interest of catastrophe bond enlarges. Some reasons were discussed to account for the results. The results show that the method is effective and can provide some guidance for the pricing of extreme flood catastrophe bonds.