Hurricane Bond Price Dependency on Underlying Hurricane Parameters

Carolyn W. Chang; Yalan Feng

doi:10.1515/apjri-2020-0017

Article

Hurricane Bond Price Dependency on Underlying Hurricane Parameters

Carolyn W. Chang and Yalan Feng

Published/Copyright: August 31, 2020

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From the journal Asia-Pacific Journal of Risk and Insurance Volume 15 Issue 1

Abstract

Hurricane bonds are parametric in nature as they have a dual-exercise structure: the first exercise is conditional on the hurricane’s physical landfall location and the second is conditional upon the embedded option ending in-the-money. We propose a coupled and physically-based hurricane bond pricing model via Monte Carlo simulation that resolves the dual exercise, which was not addressed in extant loss-based catastrophe bond pricing models. This coupled model is developed at the nexus of atmospheric science and finance by integrating hurricane risk modeling and option pricing. By applying this model to price a parametric hurricane bond, we demonstrate how a hurricane bond’s price is sensitive to its underlying hurricane’s physical parameters – genesis, heading, translation speed, velocity, and radius.

Keywords: hurricane bonds; hurricane risk management; parametric trigger; hurricane risk modeling; option pricing modeling

JEL classification: G13; G17; G22

Corresponding author: Carolyn W. Chang, Department of Finance, California State University, Fullerton, USA, E-mail: cchang@fullerton.edu

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Received: 2020-05-01

Accepted: 2020-06-15

Published Online: 2020-08-31

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Articles in the same Issue

https://doi.org/10.1515/apjri-2020-0017

Keywords for this article

hurricane bonds; hurricane risk management; parametric trigger; hurricane risk modeling; option pricing modeling