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Hybrid Cat-bonds

Author

Listed:
  • Pauline Barrieu

    (London School of Economics)

  • Henri Loubergé

    (University of Geneva and Swiss Finance Institute)

Abstract

Natural catastrophes attract regularly the attention of media and have become a source of public concern. From a financial viewpoint, natural catastrophes represent idiosyncratic risks, diversifiable at the world level. But for reasons analyzed in this paper reinsurance markets are unable to cope with this risk completely. Insurance-linked securities, such as cat bonds, have been issued to complete the international risk transfer process, but their development is disappointing so far. This paper argues that downside risk aversion and ambiguity aversion explain the limited success of cat bonds. Hybrid cat bonds, combining the transfer of cat risk with protection against a stock market crash, are proposed to complete the market. Using the concept of market modified risk measure, the paper shows that replacing simple cat bonds with hybrid cat bonds would lead to an increase in market volume.

Suggested Citation

  • Pauline Barrieu & Henri Loubergé, 2007. "Hybrid Cat-bonds," Swiss Finance Institute Research Paper Series 07-27, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp0727
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    References listed on IDEAS

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    1. Walter Kielholz & Alex Durrer, 1997. "Insurance Derivatives and Securitization: New Hedging Perspectives for the US Cat Insurance Market," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 22(1), pages 3-16, January.
    2. Sujoy Mukerji & Jean-Marc Tallon, 2001. "Ambiguity Aversion and Incompleteness of Financial Markets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 68(4), pages 883-904.
    3. Paul K Freeman, 2001. "Hedging Natural Catastrophe Risk in Developing Countries," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 26(3), pages 373-385, July.
    4. Robert J. Barro, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 121(3), pages 823-866.
    5. Barrieu, Pauline & El Karoui, Nicole, 2005. "Inf-convolution of risk measures and optimal risk transfer," LSE Research Online Documents on Economics 2829, London School of Economics and Political Science, LSE Library.
    6. Cummins, J. David & Lalonde, David & Phillips, Richard D., 2004. "The basis risk of catastrophic-loss index securities," Journal of Financial Economics, Elsevier, vol. 71(1), pages 77-111, January.
    7. Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
    8. Martin Nell & Andreas Richter, 2004. "Improving Risk Allocation Through Indexed Cat Bonds," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 29(2), pages 183-201, April.
    9. Pauline Barrieu & Nicole El Karoui, 2005. "Inf-convolution of risk measures and optimal risk transfer," Finance and Stochastics, Springer, vol. 9(2), pages 269-298, April.
    10. Robert E. Hoyt & Kathleen A. McCullough, 1999. "Catastrophe Insurance Options: Are They Zero-Beta Assets?," Journal of Insurance Issues, Western Risk and Insurance Association, vol. 22(2), pages 147-163.
    11. Philippe Artzner & Freddy Delbaen & Jean‐Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228, July.
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    Citations

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    Cited by:

    1. Borensztein, Eduardo & Cavallo, Eduardo & Jeanne, Olivier, 2017. "The welfare gains from macro-insurance against natural disasters," Journal of Development Economics, Elsevier, vol. 124(C), pages 142-156.
    2. Bjoern Hagendorff & Jens Hagendorff & Kevin Keasey, 2013. "The Shareholder Wealth Effects of Insurance Securitization: Preliminary Evidence from the Catastrophe Bond Market," Journal of Financial Services Research, Springer;Western Finance Association, vol. 44(3), pages 281-301, December.
    3. Perrakis, Stylianos & Boloorforoosh, Ali, 2013. "Valuing catastrophe derivatives under limited diversification: A stochastic dominance approach," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 3157-3168.
    4. J. David Cummins & Mary A. Weiss, 2009. "Convergence of Insurance and Financial Markets: Hybrid and Securitized Risk‐Transfer Solutions," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 76(3), pages 493-545, September.
    5. Marc Gürtler & Martin Hibbeln & Christine Winkelvos, 2016. "The Impact of the Financial Crisis and Natural Catastrophes on CAT Bonds," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 83(3), pages 579-612, September.
    6. Lo, Chien-Ling & Lee, Jin-Ping & Yu, Min-Teh, 2013. "Valuation of insurers’ contingent capital with counterparty risk and price endogeneity," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5025-5035.
    7. Stylianos Perrakis & Ali Boloorforoosh, 2018. "Catastrophe futures and reinsurance contracts: An incomplete markets approach," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 38(1), pages 104-128, January.
    8. Gibson, Rajna & Habib, Michel A. & Ziegler, Alexandre, 2014. "Reinsurance or securitization: The case of natural catastrophe risk," Journal of Mathematical Economics, Elsevier, vol. 53(C), pages 79-100.
    9. Dionne, Georges & Harrington, Scott, 2017. "Insurance and Insurance Markets," Working Papers 17-2, HEC Montreal, Canada Research Chair in Risk Management.

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    More about this item

    Keywords

    Risk management; Risk transfer; Catastrophes; Risk measures; Reinsurance; Optimal design;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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