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Dependence structure of CAT bonds and portfolio diversification: a copula-GARCH approach

Adlane Haffar () and Éric Le Fur ()
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Adlane Haffar: University of Science and Technology Houari Boumediene
Éric Le Fur: INSEEC Grande Ecole

Journal of Asset Management, 2022, vol. 23, issue 4, No 2, 297-309

Abstract: Abstract This paper analyzes advantages of investing in catastrophe bonds (CATs) in terms of portfolio diversification. Indeed, the increase in environmental disasters and their economic and financial consequences are still poorly covered by insurance and reinsurance companies. As a result, there is a rapid growth in the use of catastrophe bonds on the financial markets, which can allow the transfer of risks to the capital market. We use copula-GARCH models to test the time-varying dependence of CATs, in a portfolio composed of six stock markets (CAC 40, DJIA, EUROSTOXX 50, FTSE 100, HANGSENG, and NIKKEI 225). Our results reveal that the CATs display the highest risk-adjusted performer. This security may be a good complement to a portfolio for investors seeking to optimize their risk-adjusted returns. In addition, the CATs are one of the best diversifiers. Finally, the CATs are the asset that increases the lowest the probability of extreme co-variations with its benchmark portfolio.

Keywords: CAT bonds; Copula-GARCH model; Portfolio diversification; Portfolio risk; Robust MCD portfolio (search for similar items in EconPapers)
JEL-codes: C58 G11 G12 G22 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1057/s41260-022-00271-3

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