Nondiversification Traps in Catastrophe Insurance Markets

Posted: 17 Mar 2009

See all articles by Rustam Ibragimov

Rustam Ibragimov

Harvard University - Department of Economics

Dwight M. Jaffee

University of California, Berkeley - Finance Group; National Bureau of Economic Research (NBER)

Johan Walden

University of California, Berkeley - Finance Group

Date Written: March 2009

Abstract

We develop a model for markets for catastrophic risk. The model explains why insurance providers may choose not to offer insurance for catastrophic risks and not to participate in reinsurance markets, even though there is a large enough market capacity to reach full risk sharing through diversification in a reinsurance market. This is a “nondiversification trap.” We show that nondiversification traps may arise when risk distributions have heavy left tails and insurance providers have limited liability. When they are present, there may be a coordination role for a centralized agency to ensure that risk sharing takes place.

Suggested Citation

Ibragimov, Rustam and Jaffee, Dwight M. and Walden, Johan, Nondiversification Traps in Catastrophe Insurance Markets (March 2009). The Review of Financial Studies, Vol. 22, Issue 3, pp. 959-993, 2009, Available at SSRN: https://ssrn.com/abstract=1359525 or http://dx.doi.org/hhn021

Rustam Ibragimov (Contact Author)

Harvard University - Department of Economics ( email )

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HOME PAGE: http://www.economics.harvard.edu/faculty/ibragimov/ibragimov.html

Dwight M. Jaffee

University of California, Berkeley - Finance Group ( email )

Haas School of Business
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Berkeley, CA 94720
United States

National Bureau of Economic Research (NBER)

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Johan Walden

University of California, Berkeley - Finance Group ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
(510) 643-0547 (Phone)

HOME PAGE: http://www.haas.berkeley.edu/faculty/walden.html

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