Market-Consistent Valuation of Natural Catastrophe Risk

Natural catastrophe risk is increasingly being covered through alternative capital instead of reinsurance. Since most such instruments do not trade in an active market, their ongoing valuation is a challenge. As a solution, we propose to exploit pricing information embedded in secondary market catastrophe bond quotes. Specifically, we use a reduced form model to extract implied Poisson intensities from regularly observed prices. Next, we show that the intensities can be explained by time to maturity and modeled probability of first loss. Along these two dimensions, we estimate smooth intensity surfaces that allow investors to mark illiquid catastrophe risk positions to market.