Defaultable Catastrophe Bonds with Doubly Stochastic Poisson Losses and Liquidity Risk
Catastrophe bond (CAT bond) is one of the modern financial instruments to transfer the risk of natural disasters to capital markets. In this project, we provide a structure of payoffs for a zero-coupon CAT bond in which the premature default of the issuer is also considered. The defaultable CAT bond price is computed by Monte Carlo simulations under stochastic interest rates with losses generated by a doubly stochastic Poisson process. In the underlying Poisson process, the intensity of occurrence is assumed to follow a geometric Brownian motion. Moreover, the issuer's daily total asset value is modeled with the approach by Duan et al. (1997), and the liquidity process is incorporated to capture the additional return of investors. Finally, a sensitivity analysis is carried out to explore the effects of the key parameters on the CAT bond price.