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Insurance and Financial Hedging of Oil Pollution Risks

  • André SCHMITT
  • Sandrine SPAETER
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    The current international regime that regulates maritime oil transport calls for financial contributions by oil firms once an oil spill has occurred. Their percentage contribution to the International Oil Pollution Compensation Fund depends only on their level of activity. In this paper, we show that this compensation regime would be more efficient if contributing oil companies adopted financial strategies to hedge against oil pollution risks. The optimal coverage contract is such that standard insurance is useful to manage small and medium oil spills, while investments on financial markets help to cover large oil spills, less frequent but much more catastrophic for society. We also show that the prevention of oil spills increases when insurance is combined with a financial hedging strategy. This positive effect on prevention is further enhanced if firms have the opportunity to send signals about their risk-reducing activities to potential investors.

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    File URL: http://www.beta-umr7522.fr/productions/publications/2004/2004-14.pdf
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    Paper provided by Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg in its series Working Papers of BETA with number 2004-14.

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    Date of creation: 2004
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    Handle: RePEc:ulp:sbbeta:2004-14
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    1. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
    2. Cormier, Denis & Magnan, Michel, 1997. "Investors' assessment of implicit environmental liabilities: An empirical investigation," Journal of Accounting and Public Policy, Elsevier, vol. 16(2), pages 215-241.
    3. André SCHMITT & Sandrine SPAETER, 2002. "Improving the Prevention of Environmental Risks with Convertible Bonds," Working Papers of BETA 2002-14, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    4. Raviv, Artur, 1979. "The Design of an Optimal Insurance Policy," American Economic Review, American Economic Association, vol. 69(1), pages 84-96, March.
    5. Ringleb, Al H & Wiggins, Steven N, 1990. "Liability and Large-Scale, Long-term Hazards," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 574-95, June.
    6. Dionne, Georges & Spaeter, Sandrine, 2003. "Environmental risk and extended liability: The case of green technologies," Journal of Public Economics, Elsevier, vol. 87(5-6), pages 1025-1060, May.
    7. Blacconiere, Walter G. & Patten, Dennis M., 1994. "Environmental disclosures, regulatory costs, and changes in firm value," Journal of Accounting and Economics, Elsevier, vol. 18(3), pages 357-377, November.
    8. Lanoie, Paul & Laplante, Benoit & Roy, Maite, 1998. "Can capital markets create incentives for pollution control?," Ecological Economics, Elsevier, vol. 26(1), pages 31-41, July.
    9. Froot, Kenneth A., 2001. "The market for catastrophe risk: a clinical examination," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 529-571, May.
    10. Schlesinger, Harris, 1999. "Decomposing catastrophic risk," Insurance: Mathematics and Economics, Elsevier, vol. 24(1-2), pages 95-101, March.
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