Valuing catastrophe bonds by Monte Carlo simulations

Victor Vaugirard

Applied Mathematical Finance, 2003, vol. 10, issue 1, 75-90

Abstract: This paper reports fairly accurate simulations of insurance-linked securities within an arbitrage-free framework, while accounting for catastrophic events and allowing for stochastic interest rates. Assessing these contingent claims exhibits features of instability rooted in the discontinuity of the payoffs of binary options around their threshold, which is magnified by possible jumps in their underlying dynamics. The error made while simulating path-dependent digital options whose underlyings obey geometric Brownian motion is used to control the estimation of digital options whose underlyings follow jump-diffusion processes. Comparative statics results highlight the hump shape of the term structure of catbond yield spreads.

Keywords: Catastrophe Bonds; Digital Options; Jump-diffusion Process; Mean-reverting Process; Variance Reduction (search for similar items in EconPapers)
Date: 2003
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Citations: View citations in EconPapers (9)

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DOI: 10.1080/1350486032000079741

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