Basis Risk of Earthquake Catastrophe Bond Trigger Using Scenario-Based versus Station Intensity–Based Approaches: A Case Study for Southwestern British Columbia

Abstract

This study investigates the effectiveness of two trigger mechanisms for parametric earthquake catastrophe bonds: scenario-based and station intensity–based approaches, in terms of basis risk. Advantages of the station intensity–based method are that balanced solutions with low total trigger errors and with similar positive and negative errors can be obtained. Two methods are applied to a case study for 2,000 conventional wood-frame houses in southwestern British Columbia. The results indicate that the station intensity–based method performs at least as well as the scenario-based method in terms of total trigger error. Moreover, model risks, as part of basis risk, are assessed by considering different spatial correlation models of peak ground motions. The use of incorrect spatial correlation models results in additional errors of the catastrophe bond trigger mechanisms.