A Bayesian Pricing Model for CAT Bonds

  • Frieder Ahrens
  • Roland Füss
  • A. Sevtap Selcuk-Kestel
Conference paper
Part of the Springer Proceedings in Mathematics & Statistics book series (PROMS, volume 73)

Abstract

This paper examines the impact of the 2005 hurricane season, particularly Hurricane Katrina, on the pricing of CAT bonds. We examine whether highly rated CAT bonds demonstrate a different relationship than subinvestment bonds between objective risk measures and the spread. The theoretical framework for this relationship is based on the Lance Financial (LFC) model, introduced by Lane (Rationale and results with the LFC cat bond pricing model, Discussion paper, Lane Financial LLC, Wilmette, 2003). The empirical results of treed Bayesian estimation confirm that the severity component of the spread has an increased impact, indicating a shift in investor perception during the pricing process. The impact of the conditional expected loss also significantly increases, but it contributes through its interaction with the attachment probability rather than through its variance. Finally, we show that the influence of conditional expected loss is also increased by investment-grade ratings, because investors who demand highly rated bonds may be more concerned about possible losses than junk bond investors.

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Copyright information

© Springer International Publishing Switzerland 2014

Authors and Affiliations

  • Frieder Ahrens
    • 1
  • Roland Füss
    • 2
  • A. Sevtap Selcuk-Kestel
    • 3
  1. 1.IBB Beteiligungsgesellschaft GmbHBerlinGermany
  2. 2.Swiss Institute of Banking and Finance (s/bf)University of St. GallenSt. GallenSwitzerland
  3. 3.Institute of Applied Mathematics, Actuarial Sciences ProgramMiddle East Technical UniversityAnkaraTurkey

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