Catastrophe bond issuance strategy (case of korean typhoon)

Abstract

A catastrophe bond (CAT bond) is a useful instrument used to prepare for financial loss incurred because of natural disasters. Since it was firstly issued by Hannover Re, the worldwide CAT bond market has increased greatly. However, the Korean government or companies have never issued CAT bonds. One of the main reasons is that they do not have experience in CAT bond issuance strategy. Also, while many papers researched the CAT bond pricing, there exists little research related to issuance strategy. In this paper, we find the optimal Korean typhoon CAT bond condition by finding a condition that maximizes the bond issuer’s utility. The observed condition is CAT bond size (face value) and coupon rate, and it is observed by conducting Monte-Carlo simulation. The needed data for simulation was collected from the Korea Meteorological Administration and the Korean National Emergency Agency. Also, the Bank of Korea provides the CPI and bond yield data. We assumed that the total needed recovery fund is raised by issuing CAT bonds and 5-year national bonds. Also, we assumed 2 different conditions. One is a predictable loss case, and the other is unpredictable loss case. In both cases, the fund should be raised by issuing small face value with large coupon rate CAT bonds. However, the optimal CAT bond size is constant when the time-dependent loss increasing rate is larger than a certain value, while the size increases as the loss increasing rate increases under random loss.