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Economic Catastrophe Bonds

Joshua D. Coval
Harvard Business School; National Bureau of Economic Research (NBER)

Jakub W. Jurek
Princeton University - Bendheim Center for Finance

Erik Stafford
Harvard Business School


April 2008

HBS Finance Working Paper No. 07-102

Abstract:     
The central insight of asset pricing is that a security's value depends on both its distribution of payoffs across economic states and state prices. In fixed income markets, many investors focus exclusively on estimates of expected payoffs, such as credit ratings, without considering the state of the economy in which default is likely to occur. Such investors are likely to be attracted to securities whose payoffs resemble those of economic catastrophe bonds - bonds that default only under severe economic conditions. We show that many structured finance instruments can be characterized as economic catastrophe bonds, but offer far less compensation than alternatives with comparable payoff profiles. We argue that this difference arises from the willingness of rating agencies to certify structured products with a low default likelihood as safe and from a large supply of investors who view them as such.

Keywords: bond pricing, structured finance, credit derivatives, collateralized debt obligation (CDO), state price density, Arrow-Debreu

JEL Classifications: G12, G13

Working Paper Series

Date posted: June 26, 2007 ; Last revised: April 13, 2008

Suggested Citation

Coval, Joshua D., Jurek, Jakub W. and Stafford, Erik, Economic Catastrophe Bonds (April 2008). HBS Finance Working Paper No. 07-102. Available at SSRN: http://ssrn.com/abstract=995249


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Contact Information

Joshua D. Coval (Contact Author)
Harvard Business School ( email )
Boston, MA 02163
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Jakub W. Jurek
Princeton University - Bendheim Center for Finance ( email )
26 Prospect Avenue
Princeton, NJ 08540
United States
(609) 258-4037 (Phone)
HOME PAGE: http://www.princeton.edu/~jjurek
Erik Stafford
Harvard Business School ( email )
Boston, MA 02163
United States
617-495-8064 (Phone)
617-496-7357 (Fax)
Feedback to SSRN (Beta)


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