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
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: Suggested Citation