Pricing risk-based catastrophe bonds for earthquakes at an urban scale

Catastrophe risk-based bonds are used by governments, financial institutions and (re)insurers to transfer the financial risk
associated to the occurrence of catastrophic events, such as earthquakes, to the capital market. In this study, we show
how municipalities prone to earthquakes can use this type of insurance-linked security to protect their building stock and
communities from economic losses, and ultimately increase their earthquake resilience. We consider Benevento, a middle-sized
historical town in southern Italy, as a case study, although the same approach is applicable to other urban areas in seismically
active regions. One of the crucial steps in pricing catastrophe bonds is the computation of aggregate losses. We compute
direct economic losses for each exposed asset based on high spatial resolution hazard and exposure models. Finally, we use
the simulated loss data to price two types of catastrophe bonds (zero-coupon and coupon bonds) for different thresholds and
maturity times. Although the present application focuses on earthquakes, the framework can potentially be applied to other
natural disasters, such as hurricanes, floods, and other extreme weather events.