The Valuation of Nature-link Bonds with Exchange Rate Risk

We develop an arbitrage approach to pricing insurance bonds bearing currency risk. It implements the technique of forward-neutral change of numeraire and computes first-passage-time distributions of drifted Brownian notions. Closed-form solutions are derived or simulations are performed depending on whether interest rates are deterministic or not. Nature risk is in general more significant than currency risk.

PONCET, P. and VAUGIRARD, V.E. (2001). The Valuation of Nature-link Bonds with Exchange Rate Risk. Journal of Economics and Finance, pp. 293-307.