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A generalized two‐factor square‐root framework for modeling occurrences of natural catastrophes

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  • Giuseppe Orlando
  • Michele Bufalo

Abstract

This work aims to forecast (over 1, 5, and 15 years) the extremes, the expected value, and the volatility of natural disasters occurrences. To achieve this objective, we adopt a generalized two‐factor square‐root model linking together occurrences and volatility through stochastic correlation (Brownian motion). We use a generalized Pareto distribution (GPD) to forecast the maximum number of occurrences as a measure of value at risk (VaR). The results are checked in terms of accuracy, compared versus some baseline models (i.e., the Poisson process and the extreme value model) and backtested.

Suggested Citation

  • Giuseppe Orlando & Michele Bufalo, 2022. "A generalized two‐factor square‐root framework for modeling occurrences of natural catastrophes," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 41(8), pages 1608-1622, December.
    • Handle: RePEc:wly:jforec:v:41:y:2022:i:8:p:1608-1622
    DOI: 10.1002/for.2880
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    References listed on IDEAS

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    1. Giuseppe Orlando & Michele Bufalo, 2021. "Interest rates forecasting: Between Hull and White and the CIR#—How to make a single‐factor model work," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 40(8), pages 1566-1580, December.
    2. Giuseppe Orlando & Rosa Maria Mininni & Michele Bufalo, 2020. "Forecasting interest rates through Vasicek and CIR models: A partitioning approach," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 39(4), pages 569-579, July.
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    6. Rehez Ahlip & Laurence A. F. Park & Ante Prodan, 2017. "Pricing currency options in the Heston/CIR double exponential jump-diffusion model," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 4(01), pages 1-30, March.
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    12. Giuseppe Orlando & Rosa Maria Mininni & Michele Bufalo, 2019. "Interest rates calibration with a CIR model," Journal of Risk Finance, Emerald Group Publishing Limited, vol. 20(4), pages 370-387, September.
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    Cited by:

    1. Willi Semmler & Fabio Della Rossa & Giuseppe Orlando & Gabriel R. Padro Rosario & Levent Kockesen, 2023. "Endogenous Economic Resilience, Loss of Resilience, Persistent Cycles, Multiple Attractors, and Disruptive Contractions," Working Papers 2309, New School for Social Research, Department of Economics.

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