Pricing Default‐Risky CAT Bonds With Moral Hazard and Basis Risk
Year: 2002
Type: article
Abstract: This article develops a contingent claim model to price a default-risky, catastrophe-linked bond. This model incorporates stochastic interest rates and more generic loss processes and allows for practical considerations of moral hazard, basis risk, and default risk. The authors compute default-free and default-risky CAT bond prices by using the Monte Carlo method. The results show that both moral hazard and basis risk drive down the bond prices substantially; these effects should not be ignored in pricing the CAT bonds. The authors also show how the bond prices are related to catastrophe occurrence intensity, loss volatility, trigger level, the issuing firm's capital position, debt structure, and interest rate uncertainty.
Source: Journal of Risk & Insurance
Authors: Jin‐Ping Lee, Min‐Teh Yu
Institution: National Yang Ming Chiao Tung University
Language: English
Subfield: Economics and Econometrics
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W2010436855