Pricing dynamics in the market for catastrophe bonds
- PDF / 970,767 Bytes
- 31 Pages / 439.37 x 666.142 pts Page_size
- 9 Downloads / 190 Views
Pricing dynamics in the market for catastrophe bonds Peter Carayannopoulos1 · Olga Kanj1 · M. Fabricio Perez1 Received: 25 July 2019 / Accepted: 3 September 2020 © The Geneva Association 2020
Abstract We study the time variation of the market price of catastrophe (CAT) bonds for the period 1999–2016. While we find an overall decreasing trend in the price of expected loss risk, large catastrophes increase this price by 34% on average. Our empirical tests show that the latter effect is temporary and unlikely to be the byproduct of behavioural changes in investors’ perceptions about catastrophic risk, as previously argued. Instead, we find evidence that changes in the price of expected loss risk may be explained by changes in investor effective risk aversion, initiated by catastrophic events triggering CAT bond losses that could bring investors closer to their habit consumption levels and lead to a hard reinsurance market environment. Contagion effects from reinsurance markets are more relevant after main catastrophes given the levels of liquidity in the markets. Furthermore, contagion effects from financial markets are minor and only relevant during the subprime financial crisis, as documented in previous studies. Keywords Catastrophe bonds · Expected loss risk · External habit · Effective risk aversion · Insurance-linked security · Natural disasters
Introduction It has been more than 20 years since the modern catastrophe bond (CAT bond) market arose in the aftermath of Hurricane Andrew. Since then, the idea of giving investors the opportunity to take part in insurance risks has gained in popularity. According to Artemis,1 issuance of CAT bonds reached USD 13.86 billion in 2018, while 1 Artemis Catastrophe Bond & Insurance-Linked Securities Deal Directory, Catastrophe bonds & ILS issued and outstanding by year, retrieved from: https://www.artemis.bm/dashboard/catastrophe-bonds -ils-issued-and-outstanding-by-year/.
Electronic supplementary material The online version of this article (https://doi.org/10.1057/s4128 8-020-00194-3) contains supplementary material, which is available to authorized users. * M. Fabricio Perez [email protected] 1
Wilfrid Laurier University, Waterloo, Canada Vol.:(0123456789)
P. Carayannopoulos et al.
there were USD 37.55 billion in CAT bonds outstanding at the end of the same year. Given the rising popularity of this asset class among investors, it is important that we understand the evolution of factors affecting CAT bond pricing. Our paper addresses this issue and examines the behaviour of CAT bond pricing over time, as well as the time variability of the factors affecting such prices. We believe our study improves our understanding of CAT bond pricing mechanics and, as a result, makes a significant contribution to the related literature. From a pricing perspective, the main driver of CAT bond risk prices is the bond expected loss (EL).2 The main objective of this paper is to study the time series evolution of the price of expected loss risk and identify its most sig
Data Loading...
