Climate Change Implications for the Catastrophe Bonds Market: An Empirical Analysis
26 Pages Posted: 27 Dec 2017 Last revised: 29 Apr 2019
Date Written: March 1, 2019
Since their introduction in the mid-1990s, the return per unit of risk or multiple on catastrophe (cat) bonds has steadily declined. This paper investigates whether this pattern is consistent with the historical evolution of natural disaster risk. Assessing the accuracy of cat bond pricing is important, since about 50% of outstanding risk capital in the cat bonds market is currently exposed to Atlantic hurricanes -a risk that climate change, among other disruptions, is expected to enhance- and pension and mutual funds in European and other OECD countries currently own about 30% of the market. In this respect, while our findings suggest that falling multiples are primarily related to the Fed's expansionary monetary stance and to portfolio shift effects, we do also find evidence of significant undervaluation of natural disaster risk in the cat bonds market. This finding, also in light of the unfailing appetite of institutional investors for such securities, casts doubts over the sanity of the market and over cat bonds as suitable investment products for risk averse investors.
Keywords: Catastrophe (cat) bonds and insurance-linked securities (ILS), multiples, global warming, climate change, El Niño Southern Oscillation, Atlantic hurricanes, semiparametric dynamic conditional correlation model.
JEL Classification: G11, G23, C32
Suggested Citation: Suggested Citation