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Effect of earthquake sequences on risk-based catastrophe bond pricing
Harsh K Mistry1, Andres Hernandez2, Philippe Guéguen2
1Department of Mechanical, Aerospace and Civil Engineering, University of Manchester, Manchester, UK.
Summary
Catastrophe bonds (cat bonds) pricing models often ignore earthquake aftershocks, leading to inaccurate risk assessment. This study introduces a time-dependent model accounting for earthquake sequences, potentially altering cat bond prices by up to 45%.
Area of Science:
- * Financial Mathematics
- * Seismology
- * Risk Management
Background:
- * Catastrophe bonds (cat bonds) are financial instruments transferring specific risks to capital markets.
- * Current cat bond pricing models typically focus on seismic mainshocks, neglecting the impact of aftershocks.
- * Empirical evidence from earthquake sequences (e.g., Central Italy 2016-2017) shows aftershocks can cause significant economic losses.
Purpose of the Study:
- * To develop and implement a time-dependent aggregate loss model for cat bond pricing.
- * To incorporate seismicity clustering and damage accumulation effects into loss computations.
- * To evaluate the impact of earthquake sequences on cat bond pricing.
Main Methods:
- * Development of a time-dependent aggregate loss model.
- * Calibration of the model using seismic events from the 2016-2017 Central Italy Earthquake sequence.
- * Application of the model to five Italian municipalities to assess cat bond pricing differences.
Main Results:
- * Aftershocks can contribute substantially to overall economic losses, contrary to standard pricing assumptions.
- * The proposed time-dependent model reveals potential discrepancies in cat bond pricing.
- * Neglecting time-dependency in pricing models can lead to price differences of up to 45%.
Conclusions:
- * Standard cat bond pricing methods are insufficient due to their neglect of earthquake sequence effects.
- * A time-dependent model is crucial for accurately pricing cat bonds in seismically active regions.
- * Accurate risk assessment and pricing of cat bonds require incorporating the full impact of earthquake sequences.
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