Pricing catastrophic bonds for earthquakes in Mexico

Abstract

After the occurrence of a natural disaster, the reconstruction can be financed with catastrophic bonds (CAT bonds) or reinsurance. For insurers, reinsurers and other corporations CAT bonds provide multi year protection without the credit risk present in reinsurance. For investors CAT bonds offer attractive returns and reduction of portfolio risk, since CAT bonds defaults are uncorrelated with defaults of other securities. As the study of natural catastrophe models plays an important role in the prevention and mitigation of disasters, the main motivation of this thesis is the pricing of CAT bonds for earthquakes in Mexico. This thesis examines the calibration of a real parametric CAT bond for earthquakes that was sponsored by the Mexican government. This thesis also derives the price of a hypothetical modeled loss CAT bond for earthquakes, which is based on the compound doubly stochastic Poisson pricing methodology from Baryshnikov et al. (1998) and Burnecki and Kukla (2003).