Loss Modeling for Pricing Catastrophic Bonds
Ivan Damnjanovic, John B. Mander and Jyotirmoy Sircar, Texas A&M University, December 2008, 80 pp. (167172-1)
In the research, a loss estimation framework is presented that directly relates seismic hazard to seismic response to damage and hence to losses. A Performance-Based Earthquake Engineering (PBEE) approach towards assessing the seismic vulnerability of structures relating an intensity measure (IM) to its associated engineering demand parameter (EDP) is used to define the demand model. An empirically calibrated tripartite loss model in the form of a power curve with upper and lower cut-offs is developed and used in conjunction with the previously defined demand model in order to estimate loss ratios. The loss model is calibrated and validated for different types of bridges and buildings. Loss ratios for various damage states take into account epistemic uncertainty as well as an effect for price surge following a major hazardous event. The loss model is then transformed to provide a composite seismic hazard-loss relationship which is used to estimate financial losses from expected structural losses.
The seismic hazard-loss model is then used to assess the expected spread, that is the interest rate deviation above the risk-free (prime) rate in order to price two types of CAT bonds: indemnity CAT bonds and parametric CAT bonds.
Keywords: Loss Modeling, Performance Based Earthquake Engineering, Catastrophic Bonds
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