Portfolio Diversification Effects of Catastrophe Bonds

46 Pages Posted: 8 Jul 2016

See all articles by Steven P. Clark

Steven P. Clark

University of North Carolina (UNC) at Charlotte

Mike Dickson

Horizon Investments; University of North Carolina at Charlotte

Faith Roberts Neale

University of North Carolina at Charlotte

Date Written: July 7, 2016

Abstract

This paper demonstrates that catastrophe (cat) bonds provide substantial benefits of diversification when added to an investor's opportunity set already consisting of securities from traditional asset classes. We find that cat bonds significantly reduce drawdown measures and tail risk under various market regimes while still enhancing risk-adjusted returns. We estimate DCC-GARCH models and find a low average correlation between cat bonds and traditional asset classes. We then conduct rigorous out-of-sample portfolio analysis using four different asset-allocation models of varying levels of estimation risk. This analysis shows superior performance compared to a dynamic and optimized benchmark portfolio. Finally, we conduct mean-variance spanning tests and provide further compelling evidence that portfolios including cat bonds lie outside of the mean-variance frontier attainable by portfolios holding traditional asset classes alone.

Keywords: catastrophe bonds, diversification benefits, out-of-sample portfolio analysis

JEL Classification: G11, G12, G22

Suggested Citation

Clark, Steven P. and Dickson, Mike and Neale, Faith Roberts, Portfolio Diversification Effects of Catastrophe Bonds (July 7, 2016). Available at SSRN: https://ssrn.com/abstract=2806432 or http://dx.doi.org/10.2139/ssrn.2806432

Steven P. Clark

University of North Carolina (UNC) at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

Mike Dickson (Contact Author)

Horizon Investments ( email )

Charlotte, NC
United States
7049193611 (Phone)
7049193611 (Fax)

HOME PAGE: http://www.horizoninvestments.com/

University of North Carolina at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

Faith Roberts Neale

University of North Carolina at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States
704-687-7636 (Phone)

HOME PAGE: http://www.belkcollege.uncc.edu/rmi

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