No Economic Catastrophe Bonds
Posted: 27 Jun 2015 Last revised: 18 May 2019
Date Written: July 7, 2018
Abstract
This paper presents a new model to describe the relation between rating and pricing for structured finance obligations. Senior structured finance obligations are backed by an asset pool and suffer losses only after subordinated tranches have been completely exhausted. For a given rating and fixed asset beta, the more diversified the asset pool, the higher is the price of the most senior tranche. Such bonds resemble government bonds which default only in the worst economic states. Bonds that fail only in the same states as the government bond must have the same default risk, the same systematic risk and the same price. But government bonds are close substitutes for the safe asset and not economic catastrophe bonds.
Keywords: Collateralized Debt Obligation (CDO); Diversification; Safe Asset; Systematic Risk; Capital Asset Pricing Model (CAPM)
JEL Classification: G11, G12
Suggested Citation: Suggested Citation