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Predicting catastrophe risk: Evidence from catastrophe bond markets

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  • Zhao, Yang
  • Yu, Min-Teh

Abstract

Compared to the past literature on prediction markets that uses small-scale observational field data or experiments, this present research examines the efficiency of such markets by studying catastrophe (CAT) bonds. We collect actual catastrophe loss data, match them with the defined trigger events of each CAT bond contract, and then employ an empirical pricing framework to obtain the excess CAT premiums in order to represent the market-based forecasts. Our results indeed show that market-based forecasts have more significant predictive content for future CAT losses than professional forecasts that use natural catastrophe risk models. Although the predictive information for CAT events is specialized and complex, our evidence supports that CAT bond markets are successful prediction markets that efficiently aggregate information about future CAT losses. Our resultsalso highlight that actual CAT losses in future periods can explain the excess CAT bond spreads in the primary market and provide support for market efficiency when pricing CAT risk.

Suggested Citation

  • Zhao, Yang & Yu, Min-Teh, 2020. "Predicting catastrophe risk: Evidence from catastrophe bond markets," Journal of Banking & Finance, Elsevier, vol. 121(C).
  • Handle: RePEc:eee:jbfina:v:121:y:2020:i:c:s0378426620302442
    DOI: 10.1016/j.jbankfin.2020.105982
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    Cited by:

    1. Wang, Guanying & Wang, Xingchun & Shao, Xinjian, 2022. "Exchange options for catastrophe risk management," The North American Journal of Economics and Finance, Elsevier, vol. 59(C).
    2. Raluca Maran, 2023. "Do Sovereign Catastrophe Bonds Improve Fiscal Resilience? An Application of Synthetic Control Method to Mexico," Economics of Disasters and Climate Change, Springer, vol. 7(3), pages 431-455, November.
    3. Wulan Anggraeni & Sudradjat Supian & Sukono & Nurfadhlina Abdul Halim, 2023. "Single Earthquake Bond Pricing Framework with Double Trigger Parameters Based on Multi Regional Seismic Information," Mathematics, MDPI, vol. 11(3), pages 1-44, January.
    4. Beer, Simone & Braun, Alexander, 2022. "Market-consistent valuation of natural catastrophe risk," Journal of Banking & Finance, Elsevier, vol. 134(C).
    5. Raluca Maran, 2023. "Drivers of sovereign catastrophe bond issuance: an empirical analysis," SN Business & Economics, Springer, vol. 3(6), pages 1-20, June.

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    More about this item

    Keywords

    Prediction markets; Catastrophe bonds; Market efficiency; Catastrophe risk; Market-based forecast;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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