Catastrophe Bonds,Reinsurance, and the Optimal Collateralization of Risk Transfer

Catastrophe bonds feature full collateralization of the underlying risk transfer and thus abandon the reinsurance principle of economizing on collateral through diversification of risk transfer. Our analysis demonstrates that this feature places limits on catastrophe bond penetration, even if the structure possesses frictional cost advantages over reinsurance. However, we also show that catastrophe bonds have important uses when buyers and reinsurers cannot contract over the division of assets in the event of insolvency and, more generally, cannot write contracts with a full menu of state‐contingent payments. In this environment, segregation of collateral—in the form of multiple reinsurance companies, as well as catastrophe bond vehicles—can ameliorate inefficiencies due to reinsurance contracting constraints by improving welfare for those exposed to default risk. Numerical simulation illustrates how catastrophe bonds improve efficiency in market niches with correlated risks, or with uneven exposure of buyers to reinsurer default.     

Catastrophe Bonds—Regulating a Growing Asset Class

As the severity of natural catastrophes continues to intensify, disaster risk management is becoming increasingly important. In order to expand the capacity of the insurance markets, insurers and reinsurers have utilized alternative risk financing mechanisms such as catastrophe (CAT) bonds. Although the CAT bond market has increased recently, past CAT bond defaults have demonstrated that there are still concerns relating to contract documentation and the collateral structure of the bonds. This article argues that additional regulation that addresses these contracting problems and financial risks would facilitate greater use of CAT bonds. Regulatory change should also include industry‐wide accounting and tax reforms that will further support risk management objectives and the growth of the market. If the CAT bond market continues to experience the growth that was witnessed in the past year and additional regulation is implemented, insurers, reinsurers and governments can benefit from the cost‐effective protection that the instruments may provide in the event of a mega‐catastrophe.     

巨灾风险债券溢价之谜的行为金融学解释

作为一种新型金融工具,巨灾风险债券自发行以来所附带的风险收益就远高于同等级传统债券的收益.尽管均值方差分析方法已证明"溢价之谜"确实存在,但从传统理论角度出发的研究并不能充分解释巨灾风险债券高溢价的成因.本文尝试用行为金融理论分析以获得较合理的解释补充.通过探讨投资者的心理、行为因素在巨灾风险债券溢价之谜中所起的重要作用,得出结论:风险厌恶、固定教育成本、模糊厌恶和羊群效应等行为导致了溢价之谜的出现.这些影响因素的发现不仅是对国际巨灾风险债券市场中的高溢价现象进行解释的重要依据,同时也为我国科学发行巨灾风险债券提供了思路.     

CAT Bonds and Other Risk-Linked Securities: State of the Market and Recent Developments

This article reviews the current status of the market for catastrophic risk (CAT) bonds and other risk-linked securities. CAT bonds and other risk-linked securities are innovative financial vehicles that have an important role to play in financing mega-catastrophes and other types of losses. The vehicles are especially important because they access capital markets directly, exponentially expanding risk-bearing capacity beyond the limited capital held by insurers and reinsurers. The CAT bond market has been growing steadily, with record amounts of risk capital raised in 2005, 2006, and 2007. CAT bond premia relative to expected losses covered by the bonds have declined by more than one-third since 2001. CAT bonds now appear to be priced competitively with conventional catastrophe reinsurance and comparably rated corporate bonds. CAT bonds have grown to the extent that they now play a major role in completing the market for catastrophic-risk finance and are spreading to other lines such as automobile insurance, life insurance, and annuities. CAT bonds are not expected to replace reinsurance but to complement the reinsurance market by providing additional risk-bearing capacity. Other innovative financing mechanisms such as risk swaps, industry loss warranties, and sidecars also are expected to continue to play an important role in financing catastrophic risk.     

Trading and liquidity in the catastrophe bond market

We provide first insights into secondary market trading, liquidity determinants, and the liquidity premium of catastrophe bonds. Based on transaction data from TRACE (Trade Reporting and Compliance Engine), we find that cat bonds are traded less frequently during the hurricane season and more often close to maturity. Trading activity indicates that the market is dominated by brokers without a proprietary inventory. Liquidity is high in periods of high trading activity in the overall market and for bonds with low default risk or close to maturity, which results from lower order processing costs. Finally, using realized bid–ask spreads as a liquidity measure, we find that on average, 21% of the observable yield spread on the cat bond market is attributable to the liquidity premium, with a magnitude of up to 141 bps for high-risk bonds.     

Calibrating CAT Bonds for Mexican Earthquakes

This article examines the calibration of a real parametric catastrophe bond (CAT bond) for earthquakes sponsored by the Mexican government, which is of a high interest as it delivers several policy‐relevant findings. The results demonstrate that a combination of reinsurance and CAT bond is optimal in the sense that it provides coverage for a lower cost and lower exposure at default than reinsurance itself. A hybrid CAT bond for earthquakes is also priced in order to reduce the basis and moral risk borne by the sponsor and to reflect the value of the loss by several variables.     

洪水巨灾债券及其定价的实证研究——基于Wang两因素模型对我国洪水债券定价的分析

近年来,巨灾频发,巨灾债券已成为国际公认而又行之有效的巨灾风险转移工具。我国自然灾害多发,全国有2／3的国土面积遭受洪水威胁。因此,在我国发行巨灾债券特别是洪水巨灾债券意义重大。而发行巨灾债券的难点便在于债券的合理定价。本文收集了1961年至2009年我国洪水灾害数据,运用Wang两因素模型对其经验估计分布进行了调整,得出了中国市场上一年期洪水巨灾债券的价格。以期对我国臣灾债券的合理定价有所借鉴。最后,文章针对中国发行洪水巨灾债券的细节方面提出了建议。     

The Optimal Write-Down Coefficients in a Percentage for a Catastrophe Bond

Catastrophe bonds, also known as CAT bonds, are insurance-linked securities that help to transfer catastrophe risks from insurance industry to bond holders. When the aggregate catastrophe loss exceeds a specified amount by the maturity, the CAT bond is triggered and the future bond payments are reduced. This article first presents a general pricing formula for a CAT bond with coupon payments, which can be adapted to various assumptions for a catastrophe loss process. Next, it gives formulas for the optimal write-down coefficients in a percentage, implemented by Monte Carlo simulations, which maximize two measurements of risk reduction, hedge effectiveness rate (HER) and hedge effectiveness (HE), respectively, and examines how the optimal write-down coefficients in a percentage help reinsurance or insurance companies to mitigate extreme catastrophe losses. Last, it demonstrates how the number of coupon payments, loss share, retention level, strike price, maturity, frequency, and severity parameters of the catastrophe loss process and different interest rate models affect the optimal write-down coefficients in a percentage with numerical examples for illustrations.     

Accuracy of Premium Calculation Models for CAT Bonds—An Empirical Analysis

CAT bonds are of significant importance in the field of alternative risk transfer. Because the market of CAT bonds is not complete, the application of an appropriate pricing model is of high relevance. We apply different premium calculation models to compare them with regard to their predictive power. Without taking the financial crisis into account, a version of the Wang transformation model and the linear model are the most accurate ones. In contrast, under consideration of the financial crisis, all analyzed models are approximately equivalent. Furthermore, we find that CAT bond specific information does not improve out‐of‐sample results.     

On the test of the correction mechanism for mis-pricing between assets using a statistical yield spread model

This paper investigates the existence of a correction mechanism for mis-pricing between Japanese stock and bond. By this correction mechanism we mean that when deviations occur from the equilibrium levels of the expected return differentials between stock and bond — the risk premium differentials, the market will tend to correct the mis-pricing and bring the expected return differentials back to the equilibrium levels. We assume that the yield spread between the predicted earnings price ratio of stock and the yield to maturity of bond reflects the risk premium between stock and bond, and estimate the equilibrium risk premium differentials and mis-prices between stock and bond by modelling their behaviors with a statistical yield spread model (SYS). Empirical results strongly indicate the existence of the mis-pricing correction mechanism, suggesting the inefficiency of securities markets.     

The Variation of Economic Risk Premiums in Real Estate Returns

We examine the predictable components of returns on stocks, bonds, and real estate investment trusts (REITs). We employ a multiple-beta asset pricing model and find that there are varying degrees of predictability among stocks, bonds, and REITs. Furthermore, we find that most of the predictability of returns is associated with the economic variables employed in the asset pricing model. The stock market risk premium is highly important in capturing the predictable variation in stock portfolios, and the bond market risk premiums (term and risk structure of interest rates) are important in capturing the predictable variation in bond portfolios. For REITs, however, both the stock and bond market risk premiums capture the predictable variation in returns. REITs have comparable return predictability to stock portfolios. We conclude that there is an important economic risk premium for REITs that are not captured by traditional multiple-beta asset pricing models.     

债券信用溢价的共同因子与结构变化:基于机器学习方法

共同因子是刻画风险溢价的重要基础,将共同因子模型应用于公司债券市场有助于合理估计信用风险溢价.本文利用机器学习算法探究债券信用溢价因子的存在性以及结构变化后发现:规模、下行风险、价值、波动率以及流动性等五个公司债券共同因子对单个债券信用溢价有较好的解释能力,动量因子对信用溢价的解释能力较差,流动性因子具有较强的逆周期防...     

Examining the bond premium puzzle with a DSGE model

The basic inability of standard theoretical models to generate a sufficiently large and variable nominal bond risk premium has been termed the “bond premium puzzle.” We show that the term premium on long-term bonds in the canonical dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to the data. We find that introducing long-memory habits in consumption as well as labor market frictions can help fit the term premium, but only by seriously distorting the DSGE model's ability to fit other macroeconomic variables, such as the real wage; therefore, the bond premium puzzle remains.     

A consumption-based model of the term structure of interest rates

This paper proposes a consumption-based model that accounts for many features of the nominal term structure of interest rates. The driving force behind the model is a time-varying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expected inflation. When calibrated to data on consumption, inflation, and the aggregate market, the model produces realistic means and volatilities of bond yields and accounts for the expectations puzzle. The model also captures the high equity premium and excess stock market volatility.     

Fragmentation and heterogeneity in the euro-area corporate bond market: Back to normal?

We assess the degree of market fragmentation in the euro-area corporate bond market by disentangling the determinants of the risk premium paid on bonds at origination. By looking at over 2400 bonds we are able to isolate the country-specific effects which are a suitable indicator of the market fragmentation. We find that, after peaking during the sovereign debt crisis, fragmentation shrank in 2013 and receded to pre-crisis levels only in 2014. However, the low level of estimated market fragmentation is coupled with a still high heterogeneity in actual bond yields, challenging the consistency of the new equilibrium.     

Identifying volatility risk premia from fixed income Asian options

Fixed income options are frequently adopted by companies to hedge interest rate risk. Their payoff dependence on the cumulative short-term rate makes them particularly informative about interest rate volatility risk. Based on a joint dataset of bonds and Asian interest rate options, we study the interrelations between bond and volatility risk premia in a major emerging fixed income market. We propose a dynamic term structure model that generates an incomplete market compatible with a preliminary empirical analysis of the dataset. Approximation formulas for at-the-money Asian option prices avoid the use of computationally intensive Fourier transform methods, allowing for an efficient implementation of the model. The model generates a bond risk premium strongly correlated with a widely accepted emerging market benchmark index (EMBI-Global), and a negative volatility risk premium, consistent with the use of Asian options as insurance in this market.     

Bond Risk Premia and The Exchange Rate

In emerging market economies, currency appreciation goes hand in hand with compressed sovereign bond spreads, even for local currency sovereign bonds. This yield compression comes from a reduction in the credit risk premium. Crucially, the relevant exchange rate involved in yield compression is the bilateral U.S. dollar exchange rate, not the trade-weighted exchange rate. Our findings highlight endogenous co-movement of bond risk premia and exchange rates through the portfolio choice of global investors who evaluate returns in dollar terms.     

A mean/variance approach to long-term fixed-income portfolio allocation

Abstract

Long-term investments in bonds offer known returns, but with risks corresponding to defaults of the underwriters. The excess return for a risky bond is measured by the spread between the expected yield and the risk-free rate. Similarly, the risk can be expressed in the form of a default spread, measuring the difference between the yield when no default occurs and the expected yield. For zero-coupon bonds and for actual market data, the default spread is proportional to the probability of default per year. The analysis of market data shows that the yield spread scales as the square root of the default spread. This relation expresses the risk premium over the risk-free rate that the bond market offers, similarly to the risk premium for equities. With these measures for risk and return, an optimal bond allocation scheme can be built following a mean/variance utility function. Straightforward computations allow us to obtain the optimal portfolio, depending on a pre-set risk-aversion level. As for equities, the optimal portfolio is a linear combination of one risk-free bond and a risky portfolio. Using the scaling law for the default spread allows us to obtain simple expressions for the value, yield and risk of the optimal portfolio.     

基于套利理论与ICIR模型的债券市场发行定价偏离研究

基于套利定价理论与利率期限结构理论,运用Tobit多元线性回归模型,得出债券发行定价的主要影响因素为债券无风险利率、债券期限溢价、债项信用评级、债券主体信用评级和债券赎回风险溢价,在此基础上再通过改进的CIR定价模型(ICIR)对2006～2010年各债券定价偏离现象进行研究的结果表明,在1%的显著性水平上,ICIR模型测算的债券理论价格通过了二级市场的定价检验,ICIR模型对债券发行定价偏离进行检验具有较强的合理性;同时,从发行年份来看,近五年来,债券定价偏离总体呈逐年下降趋势,债券发行定价与ICIR定价与二级市场定价逐步接轨,市场化程度越来越高。     

短期融资券市场效率研究——基于价差分解的视角

在完全有效市场条件下,信用风险是反映信用类债券特征的最基本信息,也是决定价差的关键因素。本文通过对中国信用类债券中短期融资券的价差分解发现,虽然信用风险显著影响短期融资券定价,但市场风险才是影响其价差的最主要因素。此外,市场流动性不足降低了市场运行效率,导致流动性溢价总体为负。上述研究结果表明我国短期融资券市场化的定价机制虽已初步形成,但市场效率总体仍然偏低。