PRICING CATASTROPHIC BOND PREMIUMS USING EXTREME VALUE THEORY APPROACH: EARTHQUAKE IN MEGATHRUST MID 2 SUMATERA

• Main Author: Raissa, Regina
• Format: Final Project
• Language: Indonesia
• Online Access: https://digilib.itb.ac.id/gdl/view/42391
• Institution: Institut Teknologi Bandung

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.