Abstract
An earthquake is a big disaster that might cause a large amount of loss. Various ways had been proposed to overcome this situation, including the usage of catastrophe bonds. In this study, we propose an earthquake catastrophe bond in which both the coupon payment and principal payment are affected by the occurrence of earthquakes during the period. The pricing of this bond consists of several steps as follows: (1) obtain the earthquake data, (2) model the probability distribution of earthquake magnitude and depth, (3) propose the catastrophe bond's payment structure, and (4) derive the price formula. A numerical study using the data of earthquakes around Java and Sulawesi, Indonesia, is provided. We find that these data can be modeled well using Generalized Extreme Value (GEV) distribution, Rayleigh distribution, and Generalized Pareto distribution. Consequently, the price of catastrophe bonds can be determined using these distribution.
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