Diversification Through Catastrophe Bonds: Lessons from the Subprime Financial Crisis

Carayannopoulos, Peter, and M. Fabricio Perez. "Diversification through Catastrophe Bonds: Lessons from the Subprime Financial Crisis." The Geneva Papers on Risk and Insurance-Issues and Practice 40.1 (2015): 1-28.

50 Pages Posted: 29 Jun 2014 Last revised: 20 Jan 2015

See all articles by M. Fabricio Perez

M. Fabricio Perez

Wilfrid Laurier University - School of Business & Economics

Peter Carayannopoulos

Wilfrid Laurier University - School of Business & Economics

Date Written: December 27, 2013

Abstract

Are Catastrophe bonds (CAT bonds) zero beta investments? Are they a valuable new source of diversification for investors? We study these questions by analyzing 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, the improved structures for new CAT bonds issued since 2009 seem to be positively received by the market, as CAT bond betas returned to pre-crisis levels.

Keywords: Catastrophe Bonds, Financial Crisis, GARCH, Diversification

JEL Classification: G22, G12

Suggested Citation

Perez, Marcos Fabricio and Carayannopoulos, Peter, Diversification Through Catastrophe Bonds: Lessons from the Subprime Financial Crisis (December 27, 2013). Carayannopoulos, Peter, and M. Fabricio Perez. "Diversification through Catastrophe Bonds: Lessons from the Subprime Financial Crisis." The Geneva Papers on Risk and Insurance-Issues and Practice 40.1 (2015): 1-28., Available at SSRN: https://ssrn.com/abstract=2459974 or http://dx.doi.org/10.2139/ssrn.2459974

Marcos Fabricio Perez (Contact Author)

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada
519-884 0710 (Phone)
519-884 0201 (Fax)

HOME PAGE: http://www.public.asu.edu/~mfperez/

Peter Carayannopoulos

Wilfrid Laurier University - School of Business & Economics ( email )

80-University Avenue west
Waterloo, Ontario N2L 3C5
Canada

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