Financial Research Journal

Financial Research Journal

Pricing Catastrophe Insurance-Linked Securities for Earthquake Risk in Iran

Document Type : Research Paper

Authors
Laleh Dastmalchi 1
Kiumars Shahbazi 2
Hossein Gholami 3
1 Ph.D. Candidate, Department of Economics, Faculty of Economics and Management, University of Urmia, Urmia, Iran.
2 Prof., Department of Economics, Faculty of Economics and Management, University of Urmia, Urmia, Iran.
3 Associate Prof., Department of Mathematics and Statistics, Statistics, Faculty of science, University of Urmia, Urmia, Iran.
10.22059/frj.2025.388962.1007697
Abstract
Objective
Given the importance of insurance-linked securities (ILS) as effective instruments for the development of financial markets, the main objective of this study is to price catastrophe reinsurance securities related to earthquake risks in Iran. Unlike most previous studies—especially in the Iranian context—that have primarily focused on theoretical frameworks and preliminary feasibility analyses, the present research addresses one of the most challenging aspects of the topic by emphasizing the practical pricing of these instruments. Relying on real-world data, this study examines the pricing of catastrophe bonds under various conditions, including single-period and multi-period structures. Additionally, the impact of different levels of risk premiums is analyzed, considering the heterogeneity in investors’ risk preferences.

Methods
This research is classified as applied research in terms of its objectives and as analytical research in terms of its analysis methods. The study utilizes real data from the Seismology Center of the Geophysics Institute at the University of Tehran, covering the years 2006 to 2018 (considering data accessibility limitations). Additionally, to calculate the bond prices, a standard risk-neutral pricing tool suitable for Iran's infrastructure has been employed, with the analysis conducted using R software.

Results
In this study, we aimed to calculate the prices of catastrophe bonds related to earthquakes in both a single-period (one year) and a multi-period (five years) framework using equilibrium pricing theory. The results indicate that as the frequency of repetitions within the pricing model structure increases, the price variance decreases significantly, suggesting that the model is both consistent and computationally efficient. It is worth noting that although the decline in bond prices with increasing maturity is a theoretically predictable phenomenon, the findings of this study, based on real-world data, indicate that this decline is significantly more pronounced and meaningful over longer-term horizons than what is merely suggested by theory. This insight serves as an important warning for financial instrument designers in the insurance industry and potential investors, emphasizing the need for greater caution in selecting bond maturities to avoid a substantial reduction in expected returns. Additionally, bond prices are also reduced when the risk-reward ratio component increases. In other words, the lower the risk-reward ratio, the more willing buyers are to pay a higher price for the bonds.

Conclusion
The results of this research enabled the precise calculation of the prices of catastrophe bonds specifically for earthquakes. By comparing the one-period and multi-period models, as well as considering various risk premiums, the findings align with existing theories on security pricing. Given the necessity of this discussion, especially in light of Iran's earthquake risk, this model presents an effective approach for pricing catastrophe insurance securities related to earthquakes. It allows for the transfer of earthquake insurance risk from the insurance market to the capital market, capitalizing on the potential to attract risk-seeking investors who are looking for appealing investment opportunities. Overall, the issuance of insurance securities not only helps address liquidity challenges faced by insurance companies but can also contribute to reducing excess liquidity in the economy, thereby supporting inflation control.
Keywords
Insurance-linked securities
Pricing of securities
Risk-neutral valuation
Risk transfer.
Subjects
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Financial Research Journal
Volume 28, Issue 3
2026
Pages 716-741