Pricing of climate change catastrophe bonds in Kenya

Abstract

Catastrophe bonds have become popular with insurance companies, world over, since their invention in 1996 because of their ability to hedge the insurer against catastrophic risks. With increasing cost and burden on the public budget due to catastrophic disasters in developing countries, a government issued catastrophe bond can be suggested as a timely solution (Mahul & Cummins 2008). Since the financial impact of drought in Kenya has been regarded as catastrophic over the years, this research sought to find out what the price of a drought linked zero coupon CAT bond issued by the Kenyan government would be. Single trigger zero coupon catastrophe bonds launched on 1st August 2017 and set to have varying maturities of 91 days, 182 days and one year were priced under various contract terms. The underlying trigger chosen was drought, which was defined as rainfall amounts falling below the long term average of 47.90 millimeters.