Pricing in the Primary Market for Cat Bonds: New Empirical Evidence

We present empirical evidence from the primary market for cat bonds, which provides new insights concerning the prevailing pricing practice of these instruments. For this purpose, transactional information from a multitude of sources has been collected and cross-checked in order to compile a data set comprising virtually all cat bond tranches that were launched between June 1997 and December 2012. In order to identify the main determinants of the cat bond spread at issuance, a series of OLS regressions with heteroskedasticity and autocorrelation consistent standard errors is run. Our results confirm the expected loss as the most important factor. Apart from that, covered territory, sponsor, reinsurance cycle, and the spreads on comparably rated corporate bonds exhibit a major impact. Based on these findings, we then propose an econometric pricing model for cat bonds in the primary market that is applicable across territories, perils, and trigger types. It exhibits a robust fit across different calibration subsamples and achieves a higher in-sample and out-of-sample accuracy than several competing specifications that have been introduced in earlier work.