Failure to Share Natural Disaster Risk
73 Pages Posted: 23 Feb 2020
Date Written: November 13, 2019
I test whether asset prices reflect the preferences of financial intermediaries in a setting that is well suited to tackling concerns about omitted risk factors. I analyze catastrophe bonds whose cash flows are linked to the occurrence of natural disasters and find that 71% of the variation in their expected returns can be explained by a theoretically-motivated measure of financial intermediaries' marginal rate of substitution. Assuming that natural disasters are independent of aggregate wealth, this pricing result is inconsistent with any explanation based on macroeconomic risk factors. However, the result is consistent with intermediary asset pricing models suggesting that financial intermediaries are marginal investors in capital markets. I also show that the premium on natural disaster risk has decreased significantly in recent years and has become less responsive to the occurrence of disasters, suggesting that intermediaries' access to outside capital has improved over time.
Keywords: Risk Sharing, Intermediary Asset Pricing, Reinsurance, Catastrophe Risk, Securitization
JEL Classification: G12, G22
Suggested Citation: Suggested Citation