Economic catastrophe bonds
By: Joshua D. Coval, Jakub W. Jurek, Erik Stafford
Contributors: Jurek, Jakub W.; Stafford, Erik; Harvard Business School. Division of Research
Series: Working paper / Division of Research, Harvard Business School -- 07-102; Working paper (Harvard Business School. Division of Research) -- 07-102
Publisher: Division of Research, Harvard Business School
Published: 2007
Place of publication: Boston
Language: eng
Number of pages: 42
Description: The central insight of asset pricing is that a security's value depends on both its distribution of payoffs across economic states and state prices. In fixed income markets, many investors focus exclusively on estimates of expected payoffs, such as credit ratings, without considering the state of the economy in which default is likely to occur. Such investors are likely to be attracted to securities whose payoffs resemble those of economic catastrophe bonds-bonds that default only under severe economic conditions. We show that many structured finance instruments can be characterized as economic catastrophe bonds, but offer far less compensation than alternatives with comparable payoff profiles. We argue that this difference arises from the willingness of rating agencies to certify structured products with a low default likelihood as "safe" and from a large supply of investors who view them as such.
Notes: "June 2007"--Added t.p.

Includes bibliographical references.