TY - JOUR T1 - Optimal Choice between Cat Bond and Debt to Cover the Risks of Natural Disasters JF - The Journal of Fixed Income DO - 10.3905/jfi.2021.1.113 SP - jfi.2021.1.113 AU - Adama Sanou AU - Issouf Soumaré AU - Claude Fluet Y1 - 2021/05/03 UR - https://pm-research.com/content/early/2021/05/03/jfi.2021.1.113.abstract N2 - This article analyses the choice between non-contingent bonds and catastrophe (CAT) bonds to cover the risk of earthquakes. A dynamic stochastic optimization model with frictions was developed and shows under which conditions it may be advantageous for a government to issue a CAT bond instead of a standard non-contingent bond. We show how friction costs, such as the illiquidity premium associated with non-contingent debt issuance when a catastrophe occurs, increase the opportunity to issue CAT bonds. The calibration of the proposed model to real data allows us to estimate the price of CAT bonds to insure against earthquake losses in Quebec.TOPICS: Fixed income and structured finance, tail risksKey Findings▪ This article proposes a dynamic stochastic optimization model with frictions to analyse the choice between non-contingent bonds and catastrophe (CAT) bonds to cover the risk of earthquakes.▪ Friction costs, such as the illiquidity premium associated with non-contingent debt issuance when a catastrophe occurs, increase the opportunity to issue CAT bonds.▪ The calibration of the proposed model to real data allows us to estimate the price of CAT bonds to insure against earthquake losses in Quebec. ER -