The Welfare Gains from Macro-Insurance Against Natural Disasters

42 Pages Posted: 4 Nov 2015

See all articles by Eduardo Borensztein

Eduardo Borensztein

Inter-American Development Bank (IADB)

Eduardo A. Cavallo

Inter-American Development Bank (IDB) - Research Department

Olivier Jeanne

Johns Hopkins University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: November 2015

Abstract

This paper uses a dynamic optimization model to estimate the welfare gains that a small open economy can derive from insuring against natural disasters with catastrophe (CAT) bonds. We calibrate the model by reference to the risk of earthquakes, floods and storms in developing countries. We find that the countries most vulnerable to these risks would find it optimal to use CAT bonds for insurance only if the cost of issuing these bonds were significantly smaller than it is in the data. The welfare gains from CAT bonds range from small to substantial depending on how insurance affects the country's external borrowing constraint. The option of using CAT bonds may bring a welfare gain of several percentage points of annual consumption by improving external debt sustainability. These large gains disappear if the country can opportunistically default on its external debt.

Keywords: CAT bonds, insurance, natural disaster

JEL Classification: F3, G22

Suggested Citation

Borensztein, Eduardo and Cavallo, Eduardo A. and Jeanne, Olivier, The Welfare Gains from Macro-Insurance Against Natural Disasters (November 2015). CEPR Discussion Paper No. DP10915, Available at SSRN: https://ssrn.com/abstract=2685672

Eduardo Borensztein (Contact Author)

Inter-American Development Bank (IADB) ( email )

1300 New York Avenue NW
Washington, DC 20577
United States

Eduardo A. Cavallo

Inter-American Development Bank (IDB) - Research Department ( email )

1300 New York Ave., NW
Washington, DC 20577
United States

Olivier Jeanne

Johns Hopkins University - Department of Economics ( email )

3400 Charles Street
Baltimore, MD 21218-2685
United States

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