Pricing for catastrophe bonds based on expected-value model

Abstract

As the catastrophes cannot be avoided and result in huge economic losses, therefore the compensation issue for catastrophe losses become an important research topic. Catastrophe bonds can effectively disperse the catastrophe risks which mainly undertaken by the government and the insurance companies currently and focus on capital more effectively in broad capital market, therefore to be an ideal catastrophe securities product. This study adopts Expectancy Theory to supplement and improve the pricing of catastrophe bonds based on Value Theory. A model of expected utility is established to determine the conditions of the expected revenue R of catastrophe bonds. The pricing model of the value function is used to get the psychological value of R, U (R-R̄), for catastrophe bonds. Finally, the psychological value is improved by the value according to expected utility and this can more accurately evaluate catastrophe bonds at a reasonable price. This research can provide decision-making for the pricing of catastrophe bonds. © Maxwell Scientific Organization, 2013.