PRICING CATASTROPHIC BOND PREMIUMS USING EXTREME VALUE THEORY APPROACH: EARTHQUAKE IN MEGATHRUST MID 2 SUMATERA
Indonesia is prone to earthquakes due to its location where three tectonic plates (Indo-Australia, Eurasia, and Pacific) meet. The recovery of a region devastated by a natural disaster may cost a very large amount of money. Furthermore, even though the financial losses are covered through insuran...
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| Format: | Final Project |
| Language: | Indonesia |
| Online Access: | https://digilib.itb.ac.id/gdl/view/42391 |
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| Institution: | Institut Teknologi Bandung |
| Language: | Indonesia |
| Summary: | Indonesia is prone to earthquakes due to its location where three tectonic plates
(Indo-Australia, Eurasia, and Pacific) meet. The recovery of a region devastated
by a natural disaster may cost a very large amount of money. Furthermore, even
though the financial losses are covered through insurance schemes, it may take a
long time until all claims are paid. As an alternative way to finance the risks of
financial losses, a reinsurance company which covers losses due to catastrophic
events may use a Special Purpose Vehicle (SPV) to sell a Catastrophe Bond
(CAT-Bond) to potential investors. One appealing feature of this type of bond
is that the return of the catastrophe bond does not depend on the movement
of the financial market. As a compensation for bearing the catastrophic risks,
investors will receive regular coupon payments which consists of LIBOR (London
InterBank Offered Rate); and the catastrophe bond premium. In this Final Project,
the calculation of the catastrophe bond premium used a linear premium method
which is modified by incorporating the Extreme Value Theory for the expected
loss assessment. The moment magnitudes of the earthquakes in megathrust mid
2 Sumatera are used as the trigger for this catastrophe bond and is modeled using
the Peaks Over Threshold (POT) method. By the POT method, the excess of the
moment magnitudes data over a threshold u may be modeled by a Generalized
Pareto Distribution (GPD). Based on the analysis of a given data, with a threshold
of u = 5:6Mw, the moment magnitudes data is modeled by a GPD model with the
shape parameter = 0:1750 and the scale parameter = 0:3037. The trigger value
is determined by using empirical and parametric approach. Several triggers were
chosen and the corresponding premiums of the CAT-Bonds are calculated based on
the risk appetite of the investors: the risk-averse and risk-lover. |
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