Design Method of Trigger Event Definition of CAT Bond Focussing on Reduction in Basis Risk

Abstract eng:
It is pointed out that both risk control and risk financing are needed to reduce the seismic risk. Since an earthquake insurance, which is the most popular measure, is limited from the viewpoint of its market size, focused are the other measures that are called alternative risk transfers (hereinafter called ARTs). In many cases ARTs employ full parametric trigger to evaluate compensation, so that basis risk occurs as the difference between the real loss and the compensation, causing the higher risk cost. In this paper, the schematic design method to determine the parametric trigger that was characterized by several grids and forfeiture functions are proposed. A model portfolio consisting of 10 buildings was applied in analyzing the performance of the method. Through the application, the following findings were obtained; the existing method has a room for improvement, the proposed method can reduce the basis risk corresponding to the surplus compensation and the risk cost can be reduced without increasing the risk hedger’s risk.

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