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A simple robust model for Cat bond valuation

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  • Jarrow, Robert A.

Abstract

This note provides a simple closed form solution for valuing Cat bonds. The formula is consistent with any arbitrage-free model for the evolution of the Libor term structure of interest rates. The crucial inputs to the valuation formula are the likelihood of the catastrophe event, per unit time, and the percentage loss rate realized if an event occurs. The pricing methodology is based on the reduced form models used to price credit derivatives.

Suggested Citation

  • Jarrow, Robert A., 2010. "A simple robust model for Cat bond valuation," Finance Research Letters, Elsevier, vol. 7(2), pages 72-79, June.
    • Handle: RePEc:eee:finlet:v:7:y:2010:i:2:p:72-79
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    References listed on IDEAS

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    1. Robert A. Jarrow, 2009. "Credit Risk Models," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 37-68, November.
    2. Bakshi, Gurdip & Madan, Dilip, 2002. "Average Rate Claims with Emphasis on Catastrophe Loss Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(1), pages 93-115, March.
    3. Zanjani, George, 2002. "Pricing and capital allocation in catastrophe insurance," Journal of Financial Economics, Elsevier, vol. 65(2), pages 283-305, August.
    4. J. David Cummins, 2008. "CAT Bonds and Other Risk‐Linked Securities: State of the Market and Recent Developments," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 11(1), pages 23-47, March.
    5. Dassios, Angelos & Jang, Jiwook, 2003. "Pricing of catastrophe reinsurance and derivatives using the Cox process with shot noise intensity," LSE Research Online Documents on Economics 2849, London School of Economics and Political Science, LSE Library.
    6. Vivek J. Bantwal & Howard C. Kunreuther, 1999. "A Cat Bond Premium Puzzle?," Center for Financial Institutions Working Papers 99-26, Wharton School Center for Financial Institutions, University of Pennsylvania.
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