Accepted Paper:

Strata of ignorance in the securitization of natural catastrophes  


Emmanuel Kypraios (University of Lugano )
Dror Etzion (McGill University)
Bernard Forgues (Emlyon Business School)

Paper short abstract:

Securitization of natural catastrophes into catastrophe bonds makes risk explicit but ends up increasing opacity as strata of ignorance are sedimented when deals move from one realm of expertise to another, from geology to engineering to insurance to finance.

Paper long abstract:

Research on the 2008 financial crisis highlighted the role of concealed risks in financial securities. The prescription is to make risks explicit and clear, moving them from the shadows into the spotlight. Catastrophe bonds, a financial tool through which insurers transfer the risk of extreme natural events such as hurricanes and earthquakes to institutional investors, are paragons of financial instruments in which risk is front and center. We contend, however, that risks of securitization cannot be made fully transparent, even in these types of instruments. We tease out the tangible materiality of natural catastrophes and intangible knowledge (or lack thereof) embedded in catastrophe bond deals, and reveal that risks incorporated within these securities are sedimented one on top of the other (geological and climatological risk, engineering risk of property damages from catastrophic events, the insurability risk of these properties, and finally the financial risk of these insurance portfolios). Put differently, we hypothesize that because deals tap into different realms of expertise, they produce strata of ignorance wherein each stratum takes as a fact what the previous stratum considers uncertain. We test our hypotheses using a dataset of all 627 catastrophe bond deals issued between December 1996 and November 2015, with information about the sponsor, date of issue, size, coupons, expected loss, etc. Our results show that investors seeking to diversify portfolio risk essentially push the boundaries of certainty farther into oblivion rather than accurately quantify them.

Panel T005
Turning Things into Assets