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Diversification through Catastrophe Bonds: Lessons from the Subprime Financial Crisis

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  • Peter Carayannopoulos

    (Financial Services Research Centre, School of Business and Economics, Wilfrid Laurier University, 75 University Av. West, Waterloo, ON, N2L 3C5, Canada. E-mails: pcarayanno@wlu.ca; mperez@wlu.ca)

  • M Fabricio Perez

    (Financial Services Research Centre, School of Business and Economics, Wilfrid Laurier University, 75 University Av. West, Waterloo, ON, N2L 3C5, Canada. E-mails: pcarayanno@wlu.ca; mperez@wlu.ca)

Abstract

Are catastrophe bonds (CAT bonds) zero-beta investments? Are they a valuable new source of diversification for investors? We study these questions by analysing the dynamic relations of CAT bond returns and the returns of the stock, corporate bond and government bond markets. Our multivariate GARCH model results provide evidence that CAT bonds are zero-beta assets only in non-crisis periods. We document that CAT bonds were not immune to the effects of the recent financial crisis. With the collapse of Lehman Brothers, CAT bond returns became significantly correlated with the market. However, the relatively small effect of the crisis on CAT bonds compared with other asset classes make them a valuable source of diversification for investors. Finally, it seems that the improved structures for new CAT bonds issued since 2009 have been positively received by the market, as CAT bond betas returned to pre-crisis levels.

Suggested Citation

  • Peter Carayannopoulos & M Fabricio Perez, 2015. "Diversification through Catastrophe Bonds: Lessons from the Subprime Financial Crisis," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 40(1), pages 1-28, January.
  • Handle: RePEc:pal:gpprii:v:40:y:2015:i:1:p:1-28
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    Cited by:

    1. Eckhard Platen & David Taylor, 2016. "Loading Pricing of Catastrophe Bonds and Other Long-Dated, Insurance-Type Contracts," Papers 1610.09875, arXiv.org.
    2. Alexis Louaas & Pierre Picard, 2019. "Optimal nuclear liability insurance," Working Papers hal-01996648, HAL.
    3. Alexis Louaas & Pierre Picard, 2014. "Optimal Insurance For Catastrophic Risk: Theory And Application To Nuclear Corporate Liability," Working Papers hal-01097897, HAL.
    4. Krzysztof Burnecki & Mario Nicol'o Giuricich & Zbigniew Palmowski, 2018. "Valuation of contingent convertible catastrophe bonds - the case for equity conversion," Papers 1804.07997, arXiv.org.
    5. repec:eee:finlet:v:28:y:2019:i:c:p:431-437 is not listed on IDEAS

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