Common Risk Factors in the Cross Section of Catastrophe Bond Returns

Abstract

Catastrophe bonds are an alternative investment with high excess returns and low correlations to other asset classes, for which no factor pricing model has emerged to date. We analyze the cross section of catastrophe bond returns for the complete market between 2001 and 2020. Our empirical results show that, of all known coupon and yield spread determinants, only (seasonal) event risk significantly impacts realized returns. A novel three-factor model based on these insights explains more than 80% of the historical excess return variation in the cat bond market and eliminates the alpha left by classical benchmarks.

Keywords: Catastrophe Bonds, Asset Pricing, Factor Model

JEL Classification: C12, G01, G11, G12, G17