Catastrophe bonds and systemic risk

Abstract

Do catastrophe bonds increase or decrease the exposure and contribution to systemic risk of issuing insurance companies? And if such issues influence systemic stability, what design features of the bond and characteristics of issuing insurer cause catastrophe bond issues to destabilize the financial sector? Contrary to current conjectures of insurance regulators, we find that the contribution of ceding insurers to systemic risk actually decreases significantly after the issue of a catastrophe bond. We empirically confirm that a higher pre-issue leverage, a higher firm valuation and previous cat bond issues all exert a decreasing effect on the issuer’s systemic risk contribution.