2.592 2.

Review

Application of Compound Poisson

Process in Pricing Catastrophe
Bonds: A Systematic Literature
Review

Sukono, Hafizan Juahir, Riza Andrian Ibrahim, Moch Panji Agung Saputra , Yuyun Hidayat and
Igif Gimin Prihanto

https://doi.org/10.3390/math10152668
 mathematics
Review
Application of Compound Poisson Process in Pricing
Catastrophe Bonds: A Systematic Literature Review
Sukono 1, * , Hafizan Juahir 2 , Riza Andrian Ibrahim 3 , Moch Panji Agung Saputra 3 , Yuyun Hidayat 4
and Igif Gimin Prihanto 5
Citation: Sukono; Juahir, H.; Ibrahim,
R.A.; Saputra, M.P.A.; Hidayat, Y.;
Prihanto, I.G. Application of
Compound Poisson Process in
Pricing Catastrophe Bonds: A
Systematic Literature Review.
Mathematics 2022, 10, 2668. https://
doi.org/10.3390/math10152668
Academic Editor: Christophe
Chesneau
Received: 4 July 2022
Accepted: 27 July 2022
Published: 28 July 2022
Publisher’s Note: MDPI stays neutral
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Copyright: © 2022 by the authors.
Licensee MDPI, Basel, Switzerland.
This article is an open access article
distributed under the terms and
conditions of the Creative Commons
Attribution (CC BY) license (https://
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4.0/).
Mathematics 2022, 10, 2668. https://doi.org/10.3390/math10152668
1 Department of Mathematics, Faculty of Mathematics and Natural Sciences, Universitas Padjadjaran,
Jatinangor 45363, Indonesia
2 East Coast Environmental Research Institute (ESERI), Universiti Sultan Zainal Abidin,
Kuala Terengganu 21300, Malaysia; hafizanjuahir@unisza.edu.my
3 Doctoral Program, Department of Mathematics, Faculty of Mathematics and Natural Sciences,
Universitas Padjadjaran, Jatinangor 45363, Indonesia; riza17005@mail.unpad.ac.id (R.A.I.);
moch16006@mail.unpad.ac.id (M.P.A.S.)
4 Department of Statistics, Faculty of Mathematics and Natural Sciences, Universitas Padjadjaran,
Bandung 45363, Indonesia; yuyun.hidayat@unpad.ac.id
5 Research Center for Testing Technology and Standards, National Research and Innovation Agency,
Jakarta Pusat 10340, Indonesia; igif001@brin.go.id
* Correspondence: sukono@unpad.ac.id
Abstract: The compound Poisson process (CPP) is often used in catastrophe risk modeling, for
example, aggregate loss risk modeling. Hence, CPP can be involved in pricing catastrophe bonds
(CAT bonds) because it requires a catastrophe risk modeling method. However, studies of how
the application of CPP in pricing CAT bonds is still scarce. Therefore, this study aims to conduct a
systematic literature review (SLR) on how CPP is used in pricing CAT bonds. The SLR consists of
three stages: the literature selection, bibliometric analysis, and gap analysis. At the literature selection
stage, the 30 articles regarding the application of CPP in pricing CAT bonds are obtained. Then, the
conceptual and nonconceptual structures of the articles are mapped at the bibliometric analysis stage.
Finally, in the gap analysis stage, the application of CPP in pricing CAT bonds from the previous
studies is analyzed, and new research opportunities are studied. This research can be a reference for
researchers regarding the application of CPP in pricing CAT bonds and can motivate them to design
more beneficial ways of pricing CAT bonds with CPP in the future.
Keywords: compound Poisson process; catastrophe bond; pricing; systematic literature review;
bibliometric analysis; gap analysis
MSC: 60G55; 62P05; 91G20
1. Introduction
The frequency of catastrophic events has experienced an increasing trend in almost all
countries worldwide in the last five decades. This trend occurs for various catastrophes,
such as wildfires, droughts, earthquakes, extreme weather, floods, landslides, storms, and
volcanoes. This increasing trend for each catastrophe in the last five decades can be seen in
Figure 1 (source: https://www.emdat.be) (accessed on 15 May 2020). Figure 1 shows that
the occurrence frequency of each catastrophe each year is around the increasing trend line.
The increasing trend in catastrophic world events certainly causes a rising trend in
economic losses. The World Meteorological Organization states that the economic loss from
weather and climate catastrophes in 2010 alone was seven times that of 1970 [1], let alone
the total economic loss for all types of catastrophes. Furthermore, this increasing trend
is expected to continue in the future in line with the increasingly significant weather and
climate changes [2].
https://www.mdpi.com/journal/mathematics
Mathematics 2022, 10, 2668 2 of 19

(a) (b)

(c) (d)

(e) (f)

Figure 1. Cont.
Mathematics 2022, 10, 2668 3 of 19

(g) (h)
Figure 1. Visualization of Increasing Trends in Frequency of Wildfire (a), Drought (b), Earthquake (c),
Extreme Temperature (d), Flood (e), Landslide (f), Storm (g), and Volcanic Activity (h).

The high economic losses due to catastrophe certainly burden the country in its efforts
to overcome them. Sometimes, the quantity of catastrophe relief funds that have been
prepared is not commensurate with the economic losses incurred. Finally, the budget
and social assistance became the mainstay [3]. Therefore, contingency costs to overcome
catastrophe must be sought as soon as possible [4].
One alternative way to obtain contingency costs in strengthening the preparation of
funds for catastrophe prevention is through insurance. Of course, the mechanism used is
not an ordinary insurance mechanism because the financial situation of both the insurer and
the reinsurer will be depressed if they bear the risk of significant catastrophe losses alone [5].
Therefore, a unique insurance mechanism used is needed. In the last three decades, efforts
have been made to design unique mechanisms for insurers and reinsurers. This effort
is finally obtained by linking the risk of state economic losses due to a catastrophe with
financial security in the capital market [6]. In other words, insurers and reinsurers involve
capital market investors to jointly bear the risk of economic losses due to a catastrophe in
a country.
Catastrophe bonds (CAT bonds) are one of the most successful securities in linking
the risk of state economic losses due to a catastrophe with financial securities in the
capital market [7]. CAT bonds can provide a hefty contingency cost to countries. In 2006,
Mexico used an earthquake catastrophe insurance mechanism through a CAT bond [8]. It
was followed by other Caribbean countries, which used the exact mechanism to provide
contingency costs in response to hurricane catastrophes and earthquakes in 2014 [9]. Lastly,
Colombia, Peru, Chile, and Mexico use CAT bonds to finance the risk of earthquake losses.
Although several countries have used CAT bonds, their fair pricing mechanism, which
is a fundamental stage, must be studied further. The use of CAT bonds is still very new, thus,
there is little research on its pricing, and it can continue to be developed. CAT bond pricing
is undoubtedly different from traditional bond pricing [10] because the factors involved
vary. In addition to involving financial factors, CAT bonds also consider other factors,
namely the catastrophe risk factor. The catastrophe risk factors include catastrophe intensity,
single catastrophe loss or magnitude (in an earthquake catastrophe), and spatial elements.
In CAT bond pricing, catastrophe risk needs to be modeled first. So far, one of the
popular methods used to model catastrophe risk is the compound Poisson process (CPP).
CPP can be used to determine aggregate losses or magnitude. In other words, CPP can
integrate the model of catastrophe intensity and loss or magnitude factors. Two types of
Mathematics 2022, 10, 2668 4 of 19

CPP can be used, homogeneous and nonhomogeneous CPP. Homogeneous CPP was used
when catastrophe intensity was assumed as being constant, whereas nonhomogeneous CPP
was used when catastrophe intensity was assumed as being nonconstant [11]. Therefore,
CPP can measure catastrophe risk in the CAT bond pricing process.
The SLR on the CAT bond that has been carried out previously is briefly described
in this paragraph. An overview of the CAT bond terminology was first presented by
Canabarro et al. [12]. Their explanation shows the difference between traditional and CAT
bonds based on their risk and return. They also describe a simple model used in CAT bond
pricing. Then, Linnerooth-Bayer and Amendola [13] explain the form of loss-sharing of
state losses after the catastrophe, and they also describe what financial instruments can
be used for this loss-sharing. The results of their study show that the CAT bond is the
most efficient instrument for the country to restore its economy. Lastly, Skees et al. [14]
explained the importance of transferring state catastrophe risk to the capital market to help
fund catastrophe countermeasures for low-income countries. They also describe several
countries that have succeeded in providing funds for catastrophe prevention through
CAT bonds.
Based on this introduction, this study aims to conduct a systematic literature review
(SLR) on how to apply CPP in CAT bond pricing. The differences, which are the novelty of
our study, are as follows:
(a) This study discusses a technical problem in CPP application in pricing CAT bonds;
(b) This study analyzes the conceptual and nonconceptual structures of the literature;
(c) This study discusses the gaps in previous studies.
The SLR consists of three stages: the literature selection, bibliometric analysis, and gap
analysis. At the literature selection stage, this is conducted using the Scopus and Science
Direct databases. Then, in the bibliometric analysis, we present the mapping of conceptual
and nonconceptual structures, such as mapping the number of literary publications each
year, mapping the number of literature citations, mapping literature publishers, and map-
ping the literature keyword network. To facilitate the process of bibliometric analysis, we
use the help of the R software via the Biblioshiny Web Interface and VosViewer. Finally, a
gap analysis is carried out by examining the following matters first:
(a) Financial and catastrophic factors involved;
(b) The method used to measure risks of financial and catastrophe;
(c) The method used to estimate CAT bond price.
After (a) to (c) is assessed, the gap is determined based on the involvement of factors
and methods that have not been carried out in previous studies. This research is expected
to provide knowledge for researchers about the application of CPP in CAT bond pricing,
and this research is also expected to motivate other researchers to design more beneficial
methods of CAT bond pricing with CPP in the future.

2. Materials and Methods

2.1. Literature Collection
The literature is searched on two reliable database search engines, Scopus [15] and
Science Direct. The literature collection is conducted based on the following criteria:
(a) The type of literature is the final journal article;
(b) The title, abstract, or keyword of the literature contains the words (“catastrophe
bond” OR “CAT bond” OR “catastrophic bond”) AND (“price” OR “pricing”). We
specifically do not use keywords related to CPP. It is conducted so that the collected
literature becomes more general and more numerous;
(c) The literature is written in English;
(d) The literature is published in peer-reviewed international journals;
(e) The literature aims to design a way for pricing CAT bonds using CPP.
Mathematics 2022, 10, 2668 5 of 19

2.2. Methods of Literature Selection

In this study, the literature’s fulfillment of criteria (e) is conducted manually (not using
a search engine). It is carried out to avoid not detecting the literature by the machine even
though the literature is under the topic of this research. The manual selection stage carried
out refers to Firdaniza et al. [16] as follows:
(a) Removing duplicates and the unavailable literature from each database;
(b) Reading the abstract of articles;
(c) The reading of articles one-by-one in its entirety.

2.3. A Brief Explanation of Bibliometric Analysis

Bibliometric analysis is a series of descriptions and investigations from a list of the
literature that becomes a reference in the writing of new literature. The benefit of the
bibliometric analysis is that the conceptual and nonconceptual structures of the literature
list can be studied clearly and systematically [17]. The conceptual structure includes
the mapping of words contained in the title, abstract, and keywords. In contrast, the
nonconceptual structure provides the mapping of the most relevant researchers on a topic
and the mapping of publishers and journals from the most relevant literature. This analysis
can help researchers determine collaborators in their research, and it can permit researchers
to choose the best journal and publisher for their literature.
This study uses bibliometric analysis to analyze the conceptual and nonconceptual
structures of the collected literature. To simplify the bibliometric analysis process, we use
the software VosViewer and R. The package used in the R software is “bibliometrix”, and
the command used is “biblioshiny()” [18].

3. Results
3.1. Literature Selection
Our literature collection was conducted on 15 May 2022. The number of literature that
meets criteria (a) to (d), listed in Section 2.1, is 81 from the Scopus database and 18 from the
Science Direct database. In other words, we attained 99 articles from both databases. The
summary can be seen in Table 1.

Table 1. The Number of Literature Collected from Scopus and Science Direct Databases.

Literature Database The Number of Literature

Scopus 81
Science Direct 18

After the literature from each database is obtained, the next step is the fulfillment of
criteria (e) manually. The stages of the manual literature selection are as follows:
(a) The first stage is removing duplicates and the unavailable literature from each
database. After each piece of literature is checked, all the literature is available,
and the number of duplicate literature found is 18. We deleted these 18 pieces of
literature, leaving 81 pieces of literature selected for the next stage.
(b) The second stage is the advanced literature selection stage through reading the abstract.
In the abstract section, we look at the purpose of the literature. The literature that
aims to design ways to price CAT bonds is chosen. After each literature abstract is
read, 49 pieces of literature are obtained and then selected for the next stage.
(c) The third stage is the final literature selection stage by reading it one-by-one in its
entirety. The selected article is an article on CAT bond pricing that applies CPP. The
result is a total of the 30 articles obtained. These articles are reviewed later.
We provide a file in the form of “.bib”, which contains a database of the 30 articles
studied at the following link: bit.ly/CATBondLiteratureDatabase. A manual literature
selection process summary can be seen visually in Figure 2.
Mathematics 2022, 10, 2668 6 of 19

Figure 2. Literature Selection Process Visualization.

3.2. Bibliometric Analysis

The 30 articles obtained in the final selection stage were published in different years.
Details regarding the publication year of the 30 articles are presented in Figure 3.

Figure 3. The Annual Number of Article Publications on the Application of CPP in Pricing CAT Bonds.

Figure 3 shows that the article on how to price CAT bonds using CPP was first
published in 2002, while the most recently was published in 2022. The most articles
published in one year was five, which was in 2017. Then, there was no publication on
pricing CAT bonds in 2005, 2006, 2007, 2011, 2012, and 2016. Then, the number of articles
published each year tends to increase. It can be seen from the trend line, which has a
positive gradient. The indication is that using CAT bonds to provide contingency costs to
overcome country catastrophe can become increasingly popular yearly.
When researchers write articles about pricing CAT bonds with CPP, information about
the most impactful articles on the topic is required. Therefore, we analyzed the articles
with the most impact on pricing CAT bonds with CPP in 30 articles based on the number of
citations. The top 10 articles with the most citations are presented visually in Figure 4.
Mathematics 2022, 10, 2668 7 of 19

Figure 4. The Top 10 Articles with the Most Citations [19–28].

Figure 4 shows that the article by Lee and Yu [19] is the most impactful article on
pricing CAT bonds with CPP based on the number of citations. The article has the most
citations, 95. Then, there is information that 8 out of 10 articles with the most impact
based on the number of citations were published after 2010. It indicates no significant
relationship between the year of publication and the number of citations. Instead of having
a relationship with the year of publication, the number of citations may be influenced
by other factors, such as article quality, the novelty of the designed model, and article
accessibility. More detailed information about the top 10 articles with the most citations
can be seen in Table 2.

Table 2. Brief Overview of the Top 10 Articles with the Most Citations.

Indexed The Number

Author(s) Title
Pricing Default-Risky
CAT Bonds
Lee and Yu [19]
with Moral Hazard and
Basis Risk
Pricing and Simulations of
Nowak and Romaniuk [20]
Catastrophe Bonds
Pricing Catastrophe Bonds
Vaugirard [21]
by an Arbitrage Approach
Indifference Prices
Egami and Young [22] of Structured
Catastrophe (CAT) Bonds
Keywords
Database of Citations
- Scopus 95
Catastrophe Bonds,
Scopus and
Monte Carlo Simulations, 39
Science Direct
Risk, Stochastic Processes
Catastrophe Bonds,
Incomplete Market,
Jump-diffusion Process,
Scopus 38
Monte Carlo Simulations,
Path-dependent
Digital Options
Catastrophe (CAT) Bond,
Exponential Utility,
Indifference Price,
Scopus and
Jump-diffusion, 35
Science Direct
Reinsurance Strategy,
Structured
Derivative Security
Mathematics 2022, 10, 2668 8 of 19

Table 2. Cont.

Indexed The Number

Author(s) Title Keywords
Database of Citations
CAT Bond, Catastrophe
A Simple Robust Model Scopus and
Jarrow [23] Events, Reduced Form 28
for CAT Bond Valuation Science Direct
Model, Reinsurance
Catastrophe Risk
Bonds, Compound
Pricing Catastrophe
Nonhomogeneous
Risk Bonds:
Ma and Ma [24] Poisson Process, Mixed Scopus 28
A Mixed
Approximation Method,
Approximation Method
PCS Loss, Stochastic
Interest Rates
CAT Bonds, Catastrophe
Derivatives, Marked
Catastrophe Insurance Point Process, Minimum
Schmidt [25] Modeled by Shot Distance Estimation, Scopus 15
Noise Processes Self-Exciting Processes,
Shot Noise Processes,
Tail Dependence
Automated Decision
Catastrophe Bond Pricing
Making, Catastrophe
for The Two-Factor Vasicek
Bonds, Fuzzy Numbers,
Nowak and Romaniuk [26] Interest Rate Model Scopus 14
Monte Carlo Simulations,
with Automatized
Stochastics Processes,
Fuzzy Decision Making
Vasicek Model
3D Brownian Motion,
Brownian Bridge, CAT
The Valuation of
Bond Valuation,
Catastrophe Bonds with Scopus and
Lai et al. [27] Catastrophic and 10
Exposure to Currency Science Direct
Currency Exchange Risk,
Exchange Risk
Importance Sampling,
Jump-Diffusion Process
Valuing Catastrophe Bonds Asset Pricing, Catastrophe
Involving Correlation Bonds, CIR Model, Monte
Nowak and Romaniuk [28] Scopus 10
and CIR Carlo Simulations,
Interest Rate Model Stochastic Models

Table 2 shows that if the articles are reviewed from the keywords used, all articles use
the keywords “catastrophe bonds” or “CAT bonds”. In addition, almost fifty per cent of the
10 articles use the keyword “Monte Carlo simulation”. Finally, if the articles are reviewed
from their indexing point of view, almost half of the 10 articles presented are indexed in the
Scopus and Science Direct databases, while the others are only in Scopus.
In designing articles regarding the pricing of CAT bonds with CPP, one researcher
can collaborate with other researchers. Determination of this collaboration requires mea-
surement first. Therefore, we listed the top 10 researchers on this topic by the number of
articles they have written as references for the relevant authors to collaborate with. The top
10 authors of articles on determining the price of CAT bonds by applying the most CPP are
presented visually in Figure 5.
Figure 5 shows that Romaniuk is the most relevant author of a study on how to
price CAT bonds with CPP based on the articles that have been published. He published
4 articles, the highest among all authors. Nowak is in second place as the author of an
article on determining CAT bond price using CPP, with 3 articles written.
Mathematics 2022, 10, 2668 9 of 19

Figure 5. The Top 10 Authors Published Articles on the Application of CPP in Pricing CAT Bonds.

Researchers need to consider the journal that published the articles. Therefore, we
sorted the journals of the 30 articles reviewed by publication quantity. The visualization of
the 10 most relevant journals that publish articles on determining the price of CAT bonds
using CPP is presented in Figure 6.

Figure 6. The Top 10 Most Relevant Journals Publishing Articles about the Application of CPP in
Pricing CAT Bonds.

Figure 6 shows that Insurance: Mathematics and Economics is the journal with the
most significant number of articles publishing articles about how to price CAT bonds using
CPP, namely 3 articles. Then, Risks, Discrete Dynamics in Nature and Society, and Astin
Bulletin each have 2 published articles. Furthermore, the remainder is a 1 article publication.
Next, in more detail about the publishers of the 30 articles, we present a visualization of
the top 10 relevant publishers publishing articles on how to price CAT bonds with CPP
in Figure 7. Figure 7 shows that Elsevier publisher published the most articles on how to
price CAT bonds with 10 articles. Then, Taylor and Francis came in second with 5 articles,
and so on.
Mathematics 2022, 10, 2668 10 of 19

Figure 7. The Top 10 Most Relevant Publishers Publishing Articles of the Application CPP in Pricing
CAT Bonds.

Next is the analysis of topics that are often discussed between articles. The measure
used is the number of similar words that often appear in articles’ titles, abstracts, or
keywords. We visually present the number of similar words in the titles, abstracts, or
keywords of articles and their relationship in Figure 8. Visualizations are made using the
VosViewer software. Only words with multiple occurrences are considered to simplify it.

Figure 8. Visualization of Topic Relation between Articles Measured by the Number of Similar Words
that Often Appear.
Mathematics 2022, 10, 2668 11 of 19

The circle size of each word represents how often the word is discussed in the 30 arti-
cles. The larger the word circle, the more often the word is discussed, and vice versa. Then,
the connector lines between word circles represent the presence or absence of linkages
between words in the 30 articles. The more connector lines that fit into a word circle, the
more connections between the words in the circle and other words. Then, the color of the
word circle represents the cluster. Word circles of the same color indicate that the word
circles are in the same cluster. Finally, the distance between the word circles represents the
strength of the linkage between the word circles. The closer the distance between the word
circles, the stronger the relationship between the words. Figure 8 shows three-word circle
clusters colored red, green, and blue. Then, Figure 8 also shows that the circle containing
the word “catastrophe bonds” has the largest size. The word “catastrophe bonds” is often
discussed in the 30 articles. The second-largest word circle is the “costs” word circle. The
circle of the words “costs” is also related to the circle of the words “catastrophe bonds”.
It can be seen from the presence of a connector line connecting the two-word circles. It
indicates that the topic of discussion that is often discussed with “catastrophe bonds” is the
issue of costs. These costs can be in the form of economic losses due to the destruction of
essential country infrastructure. Then, Figure 8 also shows the existence of word circles that
refer to the approach used in determining the price of CAT bonds, namely the word circles
“stochastic processes”, “stochastic models”, and “random processes”. These three-word
circles indicate that instead of using a deterministic approach, the widely used approach is
a probabilistic approach through a stochastic process. In addition, there is also a circle of
words “jump-diffusion process”. The jump-diffusion process is a form of development of
CPP, which is also one of the methods in the stochastic process approach. Furthermore, in
Figure 8, there are also word circles that refer to the factors involved in determining the
price of CAT bonds, namely “stochastic interest rate”, “catastrophic event”, and “losses”.
Finally, there is also the existence of word circles that refer to the model simulation methods
in Figure 8, namely “monte carlo methods”, “monte-carlo simulations”, “monte carlo simu-
lations”, and “computer simulations”. It indicates that not all CAT bond pricing models
from each article have a closed-form solution, hence, these simulation methods determine
the solution.

3.3. SLR Results

In this section, we analyze the extent to which the application of CPP in the pricing of
CAT bonds has been carried out so far. The analysis includes how CPP is applied in pricing
CAT bonds, what financial factors are involved in pricing CAT bonds, and what methods
are used to estimate the price of CAT bonds.

3.3.1. The Application of CPP in the Pricing of CAT Bonds

In general, of the 30 articles reviewed, CPP was applied to design the first time the
claim-triggering event of CAT bonds occurred. The claim-triggering event occurs when
the attachment point of the specified claims index is exceeded within the life span of CAT
bonds. The part of the claim index most used is the indemnity index, an index of actual
losses experienced when a catastrophe occurs, or an index of losses based on the property
claim service.
Two types of CPP used in the 30 articles described the claim-triggering event of CAT
bonds for the first time. The first is a homogeneous CPP. In the homogeneous CPP, the
catastrophe intensity is assumed to be constant. The first time claim-triggering event of
CAT bonds designed with homogeneous CPP is as follows:

τ = in f {t : Lt > µ}, (1)

Mathematics 2022, 10, 2668 12 of 19

where τ is the first time the claim-triggering event of the CAT bond occurred, µ represents
the attachment point, and Lt is the homogeneous CPP representing the aggregate of
catastrophic losses until time t. In more detail, Lt is expressed as follows:

Nt
Lt = ∑ Xi , (2)
i =1

where Nt is a homogeneous Poisson process with an intensity of λ > 0 representing the

frequency of catastrophes that occur until time t, and { Xi , i = 1, 2, . . . , Nt } is a sequence of
random variables representing the i-th single catastrophe loss.
The next type of CPP is a nonhomogeneous CPP. In the nonhomogeneous CPP, the
catastrophe intensity is assumed to be not constant. In other words, the Nt involved in
Equation (2) is represented as a nonhomogeneous Poisson process with an intensity of
λt > 0. There are several assumptions applied to the CPP used in pricing CAT bonds in the
30 articles, which are as follows:
(a) Losses for each catastrophe are assumed to be independent and identically distributed.
In other words, the losses of one catastrophe with those of another do not affect each
other, and the losses of each catastrophe follow the same probability distribution.
(b) The number of catastrophe events is independent of catastrophe losses. In other
words, the number of catastrophe events does not affect the losses experienced.
Assumptions (a) and (b) may be inappropriate. It is because every assumption of
freedom does not always occur. However, it made the CAT bond pricing process simpler to
design and simulate. Homogeneous and nonhomogeneous CPP users from the 30 articles
are presented in Table 3.

Table 3. Homogeneous and Nonhomogeneous CPP Users.

CPP Type Frequency of Article The Articles

Homogeneous 17 [3,9,19–22,25,27–36]
Nonhomogeneous 13 [23,24,26,37–46]

Table 3 shows that homogeneous CPP is more widely used in pricing CAT bonds than
nonhomogeneous CPP. The catastrophe intensity is not always constant in every unit of
time, but homogeneous CPP is the most widely used.
In addition to the single claim-triggering index, some articles in the 30 articles apply
CPP in pricing CAT bonds with a multiple claim trigger index. These articles were written
by Chao and Zou [3] and Ibrahim et al. [46]. Both use the loss index and the death index.
In these two articles, CPP is applied to the design of one of the claim-triggering event times
and the two claim-triggering event times. The time when one of the claim-triggering events
of CAT bonds occurred designed with CPP is as follows:

τmin = min{τL , τD }, (3)

where τL represents the claim-triggering event of the loss index of CAT bonds that occurred
for the first time, and τD represents the claim-triggering event of the death index of CAT
bonds that occurred for the first time. In more detail, τL and τD are, respectively, expressed
as follows:
τL = inf{t : Lt > µ L } (4)
and
τD = inf{t : Dt > µ D }, (5)
where Lt represents the CPP which represents the aggregate of catastrophe losses, Dt
represents the CPP which represents the aggregate of deaths, µ L represents the attachment
point of the aggregate of catastrophe losses, and µ D represents the attachment point of the
Mathematics 2022, 10, 2668 13 of 19

aggregate of catastrophe deaths. Meanwhile, the two claim-triggering events of CAT bonds
that occurred for the first time designed with CPP are as follows:

τmax = max{τL , τD }. (6)

As a result of using the multiple claim-triggering index, additional assumptions are

imposed on the CAT bonds pricing model. These assumptions are as follows:
(a) The number of deaths for each catastrophe is assumed to be independent and identi-
cally distributed. It means that the number of deaths of one catastrophe with those
of another does not affect each other, and the number of deaths for each catastrophe
follows an equal probability distribution.
(b) The number of catastrophe events is independent of the number of catastrophe deaths.
It means that the number of catastrophic events does not affect the number of deaths
and vice versa.
(c) Catastrophic losses are independent of the number of catastrophe deaths. It means
that catastrophe losses do not affect the number of deaths and vice versa.

3.3.2. Analysis of Financial Factors Involved in Pricing CAT Bonds

This section analyzes financial factors and assumptions that apply to it in modeling
CAT bond pricing in the 30 articles studied. Similar to the standard bond pricing, the CAT
bond pricing of the 30 articles obtained involves the interest rate factor. The interest rate
factor determines the present value of the coupon and principal payments. Then, there are
two assumptions used to involve this interest rate factor. The two assumptions used are
where some use constant and nonconstant interest rates. The number of articles that apply
the assumption of constant and nonconstant interest rates is presented in Table 4.

Table 4. The Frequency of Articles Applying Constant and Nonconstant Interest Rate Assumptions.

Interest Rate Assumptions Frequency of Article The Articles

Constant 12 [9,22,25,29–34,37–39]
Nonconstant 18 [3,19–21,23,24,26–28,35,36,40–46]

Table 4 shows that of the 30 articles, 12 articles apply a constant interest rate assump-
tion, while the other 18 articles apply the assumption of a nonconstant interest rate. It
indicates that the assumption of a nonconstant interest rate is predominantly more widely
used. It is also appropriate where interest rates fluctuate in each period. In addition to
involving the interest rate factor, there is 1 article involving other financial factors, namely
the basic risk and credit risk factors. These factors are included in Lee and Yu’s [19] article.
Of the 18 articles that use nonconstant interest rates, we analyze the methods used
to model them. After our analysis, there are 6 methods used. These methods are the
Cox–Ingersoll–Ross (CIR) model, the Vasicek model, the Hull–White model, the CIR and
Vasicek models, the robust approach, and the autoregressive integrated moving average
(ARIMA) model. The number of articles using these methods is presented in Table 5.

Table 5. The Frequency of Use of the Interest Rate Models.

Interest Rate Model Frequency of Article The Articles

CIR 8 [3,19,24,28,41,43–45]
Vasicek 5 [21,26,27,35,36]
Robust Approach 2 [23,40]
CIR and Vasicek 1 [20]
Hull–White 1 [42]
ARIMA 1 [46]
Mathematics 2022, 10, 2668 14 of 19

Table 5 shows that almost half of the 18 articles that use a nonconstant interest rate
design their interest rates using the CIR model. Then, another 5 articles used the Vasicek
model. The robust approach is used in 2 articles, and the other methods are used in 1 article
each. The use of the CIR model is commonly used because, in this model, the interest rate
is guaranteed not to have a negative value. It is under the actual situation wherein the
interest rate is not negative in almost every country worldwide. Then, to model another
financial factor, the credit risk factor, Lee and Yu [19] adopted the Duan, Moreau, and
Sealey [47] model.

3.3.3. The Analysis of the CAT Bond Price Estimation Methods

Models can have closed or non-closed solutions. If the model has a closed-form
solution, the solution can be determined by ordinary arithmetic operations. If the model
does not have a closed-form solution, the solution is difficult or even impossible to decide
on by common arithmetic operations. In this section, we analyze the model solutions
from the 30 articles. The number and percentage of articles that have and do not have
closed-form solutions are presented in Figure 9.

Figure 9. The Number and Percentage of Models That Have and Do Not Have Closed-Form Solutions.

Figure 9 shows that of the 30 models in the 30 articles, 25 models (83%) do not have
a closed-form solution, and 5 other models (17%) have a closed-form solution. Thus,
of the 30 existing models, these models generally do not have a closed-shaped solution.
For models that have a closed-form solution, the authors are Jarrow [23], Sun et al. [40],
Georgiopoulos [32], Tang and Yuan [36], and Deng et al. [9]. They do not require an
alternative method to obtain the solution because this can be determined by common
arithmetic operations, whereas models that do not have a closed-form solution must use
an alternative method to determine the solution. Therefore, we analyzed the alternative
methods used from the 25 articles with these non-closed solutions. After the analysis is
carried out, to determine the closed-form solution of the model used in 25 articles, there
are 7 methods used. The methods used are the Monte Carlo method, the Quasi-Monte
Carlo method, the mixed distribution approach method, the Wang-Double-Factor model,
the numerical integral method, the combination mixed distribution approach method and
Nuel recursive method, and a combination of the Monte Carlo method and the stochastic
iteration method. The number and percentage of articles using these methods are presented
in Figure 10.
Mathematics 2022, 10, 2668 15 of 19

Figure 10. The Number and Percentage of Articles Using Each Simulation Method.

Figure 10 shows that the Monte Carlo method is the most widely used method to
obtain a non-closed solution from the model. The reason for the many uses of the Monte
Carlo method is that the Monte Carlo method is very intuitive. That is, this method is
easy to reason with logic; hence, why it is widely used. For the other methods, each is
used uniquely. The combination of the Monte Carlo method and the stochastic iteration
equation was used by Romaniuk [29], and the Quasi-Monte Carlo method was used by
Albrecher et al. [37]. Haslip and Kaishev [30] used the integral numerical method, and Ma
and Ma [24] used a mixed approximation method. The Wang-Double-Factor model method
was used by Chen et al. [31], and the combination of a mixed approximation method and
the Nuel recursive method was used by Ibrahim et al. [46].

4. Discussions
In this section, we discuss the results obtained from Section 3. The discussion includes
presenting fascinating facts and the presentation of gaps from the 30 articles that discuss
how to apply CPP to pricing CAT bonds.

4.1. The Facts of Bibliometric Analysis and SLR Results

If the 30 articles are reviewed from the number of citations provided in Section 3.2, the
articles published after 2010 are cited more frequently; they even fill many places in the top
10 articles with the greatest number of citations. However, the year of publication does not
significantly affect the number of citations. That is, other factors influence it. Other factors
may be the quality of the article, the suitability of the model with the actual situation, and
the ease of obtaining articles.
The next fact is that the number of articles on CPP application pricing CAT bonds tends
to increase yearly. The popularity of CAT bonds as a provider of catastrophe contingency
costs is rising, so knowledge about how to price them is increasingly needed. If we look at
the current condition where the frequency of catastrophes continues, research on how to
price CAT bonds with CPP will increase in the future.
Based on the analysis presented in Table 3 in Section 3.3.1, the use of homogeneous
CPP is more than nonhomogeneous CPP, even though the nonhomogeneous CPP is better
in describing the aggregate of losses and deaths because it is more in line with the actual
situation. The possible reason for this is for the sake of model simplicity. An example is
what was conducted by Lee and Yu [19]. In addition, another reason is a necessity due to
the use of an assumption or other method. An example is Chao and Zou [3], who used
Mathematics 2022, 10, 2668 16 of 19

homogeneous CPP due to copulas in designing random vectors of loss risk and fatality
risk, which require identical multivariate distributions.
Based on the analysis of the number of claim-triggering events used in the 30 articles
studied, there are exciting things where the use of multiple claim-triggering events on CAT
bonds has begun to grow in the last four years. Chao and Zou [3] first used this type of
claim-triggering event. It was then continued by Ibrahim et al. [46]. It could indicate that
the need for CAT bonds with multiple claim-triggering event types may increase. It can
undoubtedly happen along with the increasing frequency of catastrophes in the last five
decades, such as the data and facts described in Section 1.

4.2. Gap Analysis

First, we analyze the general model gap. Almost all of the existing CAT bond pric-
ing models with CPP are not specific in referring to certain types of catastrophes. The
catastrophes that these models refer to are catastrophes in general. Thus, developing CAT
bond price modeling with CPP can refer to inevitable catastrophes, such as CAT bonds for
earthquakes, volcanoes, or floods.
Next, we analyze the model gaps based on the factors involved. For CAT bonds
that use a single claim-triggering event, if each model is considered from the catastrophe
severity factor, almost all use catastrophic losses, even though other severity factors can
be used. Examples are the maximum earthquake magnitude, the maximum area flooded,
and the maximum radius of the area affected by volcanic eruptions. Therefore, this may
be developed. For CAT bonds involving multiple claim-triggering events, almost all
combinations of catastrophe severity factors used are catastrophic losses and number of
deaths, although other combinations of severity factors can also be used. For example,
the combinations of loss and magnitude of earthquakes for earthquake CAT bonds can
be considered. Therefore, this can also be a research opportunity in the future. Then, if
each model is viewed considering the financial factors involved, no model consists of the
inflation rate factor even though this factor significantly affects the present value of money
time-by-time. Therefore, the involvement of these factors can be a development.
The following model gap analysis is carried out based on the methods used in model-
ing financial and catastrophe factors. The methods used to model financial factors are fair,
with many models being used. Meanwhile, the methods used to model the catastrophe
factor are still slightly varied. Because the severity factor that almost all models use is
catastrophe loss, practically all models use a random addition process:

Nt
Lt = ∑ Xi , (7)
i =1

where Lt , t = 0, 1, 2, . . . , represents the aggregate loss at time t, Xi , i = 1, 2, . . . , Nt

represents the i-th catastrophe loss, and Nt represents the Poisson process with a catastrophe
intensity of λ > 0. A random maximum value process can be applied as an alternative to
modeling other catastrophe severity factors, such as maximum earthquake magnitude:

Mt = max{Yi , i = 1, 2, . . . , Nt }, (8)

where Mt ,t = 0, 1, 2, . . . is the maximum earthquake magnitude until time t, and Yi ,

i = 0, 1, 2, . . . , Nt represents the magnitude of the i-th earthquake. The involvement of this
method can be a new opportunity in the future.

5. Conclusions
This study presents a systematic literature review on the application of CPP in pricing
CAT bonds. In collecting articles from the Scopus and Science Direct databases, we obtained
99 articles on how to apply CPP in pricing CAT bonds. After the manual selection process,
namely duplication, abstraction, and full paper selection, the 30 articles on CPP application
in pricing CAT bonds are collected. Then, the articles are bibliometrically analyzed using R
Mathematics 2022, 10, 2668 17 of 19

software and VosViewer. The bibliometric analysis results are an overview of the 30 articles
on how to apply CPP in pricing CAT bonds. One of the results is that articles on how
to apply CPP in pricing CAT bonds tend to increase from 2002 to 2022. It indicates that
research on this topic is becomes more popular from time-to-time as the demand for CAT
bonds increases due to the tendency of the increasing frequency of world catastrophes.
Models from the 30 articles are analyzed as well. This analysis includes how CPP is
applied in pricing CAT bonds, what financial factors are involved in pricing CAT bonds,
and what methods are used to estimate the price of CAT bonds.
In general, of the 30 articles reviewed, CPP was applied to design the first time
the claim-triggering event of CAT bonds occurred. Two types of CPP were used in the
30 articles to describe the claim-triggering event of CAT bonds for the first time, namely
homogeneous CPP and nonhomogeneous CPP. In more detail, all models predominantly
involve a single claim-triggering event. Only two articles involve multiple claim-triggering
events. CAT bonds with a single claim-triggering event used catastrophe losses to measure
the severity of the catastrophe, whereas for CAT bonds with multiple claim-triggering
events, all used catastrophe losses and the number of deaths to measure the severity of
the catastrophe.
We also analyze the financial factor involved in the models. The involved fundamental
financial factor is the interest rate. It calculates the present value of the coupon and principal
payments. Two assumptions are used to model the interest rates, namely constant interest
rates and nonconstant interest rates. In addition, another financial factor is only addressed
by Lee and Yu [19], namely the credit and the basis risk. The methods used to model
nonconstant interest rates are very diverse, for example, the CIR model, the Vasicek model,
the Hull–White model, the robust approach, and the ARIMA model. The credit and the
basis risk are modeled by Lee and Yu [19], referred to as the model of Duan, Moreau, and
Sealey [47].
In terms of the form of the model solution, they have or do not have a closed-form
solution. For a model with a closed-form solution, the solution can be determined by
ordinary arithmetic operations, while for a model with no closed-form solution, the solution
is determined by the simulation method. The Monte Carlo simulation method is widely
used to determine the closed solution.
Finally, the model gaps of the 30 articles are also analyzed. In general, all articles are
not referring to a specific type of catastrophe. Therefore, designing a CAT bond pricing
model with CPP for certain types of catastrophes can be an opportunity for future research.
Then, because the catastrophe referred to is a catastrophe in general, almost all measures
of catastrophe severity used in the model are catastrophic losses. If the CAT bond price
model designed refers to a specific type of catastrophe, for example, an earthquake, the
catastrophe severity measure that can be used is the maximum earthquake magnitude.
Moreover, there is no model for determining the price of CAT bonds with CPP that involves
other financial factors, namely the inflation factor. Therefore, this is also an opportunity for
new research in the future. Finally, all methods used to model catastrophe risk factors were
CPP for random summation. It can be varied by using a random maximum value, i.e., the
maximum value of some N random variables, where N represents the random variable
of the number of catastrophes. It is hoped that this research can be used as a reference
for developing research on how to price CAT bonds with CPP and can motivate other
researchers to design more beneficial methods of CAT bond pricing in the future.

Author Contributions: Conceptualization, S. and H.J.; methodology, R.A.I. and M.P.A.S.; software,
R.A.I. and M.P.A.S.; validation, S., H.J., I.G.P. and Y.H.; formal analysis, S.; investigation, H.J.;
resources, S. and Y.H.; data curation, R.A.I. and M.P.A.S.; writing—original draft preparation, R.A.I.;
writing—review and editing, S., I.G.P. and H.J.; visualization, R.A.I. and M.P.A.S.; supervision, S.;
project administration, S. and H.J.; funding acquisition, S. All authors have read and agreed to the
published version of the manuscript.
Mathematics 2022, 10, 2668 18 of 19

Funding: This research was funded by the Directorate of Research, Community Service and Innova-
tion or DRPM Universitas Padjadjaran, grant number 1733/UN6.3.1/LT/2020.
Institutional Review Board Statement: Not applicable.
Informed Consent Statement: Not applicable.
Data Availability Statement: Data are contained within the article.
Acknowledgments: Thanks are conveyed to the Directorate of Research, Community Service and
Innovation or DRPMI Universitas Padjadjaran, who has provided a Literature Review Grant. Thanks
to East Coast Environmental Research Institute (ESERI) Universiti Sultan Zainal Abidin, Malaysia,
and Research Center for Testing Technology and Standards, National Research and Innovation
Agency, Indonesia, for supporting this research collaboration.
Conflicts of Interest: The authors declare no conflict of interest.

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