On the application of the fair valuation approach for CAT bond pricing

Innovative financing mechanisms such as risk swaps, industry loss warranties, and also CAT bonds have grown to the extent that they now play a major role in completing the market for catastrophic-risk finance. Actually, the aforementioned financial instruments provide a solid mechanism for direct transfer of the financial consequences of extreme events (hazards) into the financial market. CAT bonds are of significant importance in the field of alternative risk transfer. In the literature, we find several methodologies concerning the valuation of CAT bonds, where different pricing methodologies have been introduced in order to cope with the difficulties that exist in the pricing context. For example, a CAT bond will usually not provide a perfect hedge, and hence will require an arbitrage-free approach in an incomplete market framework. Fair valuation is a state-of-the-art mythology which can be applied to value any claim by the combination of information from the financial market and actuarial judgment. The aim of our research is to investigate new approaches on valuating and pricing CAT bonds based on the theory on fair valuation.