A Pricing Model Of CAT Bounds Based On The Loss Distribution Of Typhoon In China

Catastrophe bond is the most active transacted and widely used product among the large number of catastrophic derivatives. Catastrophe bond is an over-the-counter bond derivative which can transfer the catastrophe risk from the Insurance company and Reinsurance Company to the investors in the investment market. The income of the investors is absolutely dependent on whether the catastrophic incident which previous confirmed would happen. And the successful issue of the bond will lie in its reasonable price.China is a typhoon-prone country which suffers great losses each year. In the case of the losses, the government only can use the financial funds for compensation on account of the lack of insurance specifically for the typhoon disaster, which undoubtedly has increased the nation's financial burden. With regards to this situation and under the principle of taking the bilateral benefits of both investors and issuers, the paper attempts to devise a catastrophe bond based upon China's typhoon loss distribution and discusses the pricing model in accordance with the length of validity of catastrophe bond. In view of the characteristic of catastrophe bond which has a long term of validity, the creative point of this paper is to decompose it into the value of a zero-coupon bond and a binary option. And then price it with hedging and the discounted cash flow approach.