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Dependence structure of CAT bonds and portfolio diversification: a copula-GARCH approach

Author

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  • Adlane Haffar

    (University of Science and Technology Houari Boumediene)

  • Éric Le Fur

    (INSEEC Grande Ecole)

Abstract

This paper analyzes advantages of investing in catastrophe bonds (CATs) in terms of portfolio diversification. Indeed, the increase in environmental disasters and their economic and financial consequences are still poorly covered by insurance and reinsurance companies. As a result, there is a rapid growth in the use of catastrophe bonds on the financial markets, which can allow the transfer of risks to the capital market. We use copula-GARCH models to test the time-varying dependence of CATs, in a portfolio composed of six stock markets (CAC 40, DJIA, EUROSTOXX 50, FTSE 100, HANGSENG, and NIKKEI 225). Our results reveal that the CATs display the highest risk-adjusted performer. This security may be a good complement to a portfolio for investors seeking to optimize their risk-adjusted returns. In addition, the CATs are one of the best diversifiers. Finally, the CATs are the asset that increases the lowest the probability of extreme co-variations with its benchmark portfolio.

Suggested Citation

  • Adlane Haffar & Éric Le Fur, 2022. "Dependence structure of CAT bonds and portfolio diversification: a copula-GARCH approach," Journal of Asset Management, Palgrave Macmillan, vol. 23(4), pages 297-309, July.
    • Handle: RePEc:pal:assmgt:v:23:y:2022:i:4:d:10.1057_s41260-022-00271-3
    DOI: 10.1057/s41260-022-00271-3
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    Cited by:

    1. Wulan Anggraeni & Sudradjat Supian & Sukono & Nurfadhlina Abdul Halim, 2023. "Catastrophe Bond Diversification Strategy Using Probabilistic–Possibilistic Bijective Transformation and Credibility Measures in Fuzzy Environment," Mathematics, MDPI, vol. 11(16), pages 1-30, August.

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    More about this item

    Keywords

    CAT bonds; Copula-GARCH model; Portfolio diversification; Portfolio risk; Robust MCD portfolio;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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