Pricing of Reinsurance Contracts in the Presence of Catastrophe Bonds

A methodology for pricing of reinsurance contracts in the presence of a catastrophe bond is developed. An important advantage of this approach is that it allows for the pricing of reinsurance contracts consistent with the observed market prices of catastrophe bonds on the same underlying risk process.

Within the proposed methodology, an appropriate financial pricing formula is derived, under a market implied risk neutral probability measure for both a catastrophe bond and an aggregate excess of loss einsurance contract, using a generalised Fourier transform. Efficient numerical methods for the evaluation of this formula, such as the Fast Fourier transform and Fractional Fast Fourier transform, are considered.

The methodology is illustrated on several examples including Pareto and Gamma claim severities.

Keywords: Reinsurance, catastrophe bonds, risk neutral valuation, securitisation, Fast Fourier Transform, Fractional Fast Fourier Transform.