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Calibration of Parametric CAT Bonds. A Case Study of Mexican Earthquakes
Härdle, Wolfgang Karl | López Cabrera, Brenda
Journal of Contextual Economics – Schmollers Jahrbuch, Vol. 128 (2008), Iss. 4 : pp. 615–630
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Wolfgang Karl Härdle, Humboldt Universität zu Berlin, School of Business and Economics, Spandauer Straße 1, 10178 Berlin.
Brenda López Cabrera, Humboldt Universität zu Berlin, Institute for Statistics and Econometrics, Spandauer Straße 1, 10178 Berlin.
Abstract
The study of natural catastrophe models plays an important role in the prevention and mitigation of disasters. After the occurrence of a natural disaster, the reconstruction can be financed with catastrophe bonds (CAT bonds) or reinsurance. This paper examines the calibration of a real parametric CAT bond for earthquakes that was sponsored by the Mexican government, which is based on the estimation of the intensity rate of the arrival process of earthquake (which would trigger this particular CAT bond) from the two sides of the contract: the reinsurance and the capital markets. Additionally, the intensity rate from the historical data was estimated to conduct a comparative analysis. The results demonstrate that, under specific conditions, the financial strategy of the government, a mix of reinsurance and CAT bond, is optimal in the sense that it provides coverage of USD 450 million for a lower cost than the reinsurance itself.