Why Have Exchange-Traded Catastrophe Instruments Failed to Displace Reinsurance?

42 Pages Posted: 26 Feb 2007

See all articles by Rajna Gibson

Rajna Gibson

European Corporate Governance Institute (ECGI); University of Geneva - Geneva Finance Research Institute (GFRI)

Michel A. Habib

University of Zurich; Swiss Finance Institute

Alexandre Ziegler

University of Zurich - Department of Banking and Finance

Date Written: February 2007

Abstract

In spite of the fact that they can draw on a larger, more liquid and more diversified pool of capital than the equity of reinsurance companies, financial markets have failed to displace reinsurance as the primary risk-sharing vehicle for natural catastrophe risk. We show that this failure can be explained by differences in information gathering incentives between financial markets and reinsurance companies. Using a simple model of an insurance company that seeks to transfer a fraction of its risk exposure either through financial markets or through traditional reinsurance, we find that the supply of information by informed traders in financial markets may be excessive relative to its value for the insurance company, causing reinsurance to be preferred. We show that whether traditional reinsurance or financial markets are ultimately selected depends crucially on the information acquisition cost structure and on the degree of redundancy in the information produced. Limits on the ability of informed traders to profitably take advantage of their information make the use of financial markets more likely.

Keywords: Catastrophe risk, insurance, reinsurance, financial markets, private and public financing

JEL Classification: G22, G32

Suggested Citation

Gibson, Rajna and Habib, Michel A. and Ziegler, Alexandre, Why Have Exchange-Traded Catastrophe Instruments Failed to Displace Reinsurance? (February 2007). EFA 2007 Ljubljana Meetings Paper, Available at SSRN: https://ssrn.com/abstract=964916 or http://dx.doi.org/10.2139/ssrn.964916

Rajna Gibson

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland
+41.22.379.89.83 (Phone)

Michel A. Habib (Contact Author)

University of Zurich ( email )

Plattenstrasse 14
Zurich, 8032
Switzerland
41-44-634-2507 (Phone)
41-44-634-4903 (Fax)

HOME PAGE: http://www.isb.uzh.ch/institut/profs/mhabib.htm

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Alexandre Ziegler

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

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