CAT Bond Pricing in Uncertain Environment

Document Type : Research Paper

Authors

Department of Applied Mathematics, Faculty of Basic Sciences, Azarbaijan Shahid Madani University, Tabriz, Iran

Abstract

Catastrophe bonds are among the essential instruments in providing a financial hedge for insurance companies and their policyholders. Catastrophic events are rare, and the shortage of data turns using probability theory indefensible. On the other hand, uncertainty theory is a reliable alternative to deal with these kinds of indeterminacies. We model the problem of pricing catastrophe bonds as an uncertain optimization problem where the maximization of the cedent insurance company’s profit is constrained to the uncertain measure of ruin defined for the investors. Consequently, one could provide a tradeoff between being profitable for the ceding company and having reasonable protection for the investors. A solution to the optimization problem will be considered as the spread over the LIBOR, leading to a complete determination of the bond price. The results suggest the practicality of the model, especially the application of uncertainty theory in pricing catastrophe bonds. Finally, the uncertain ruin index is calculated for a real-world problem, and the results are compared with those obtained by probability theory.

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References

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Interdisciplinary Journal of Management Studies (Formerly known as Iranian Journal of Management Studies)
Volume 15, Issue 2
April 2022
Pages 347-364

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