CATASTROPHE BONDS - An investment analysis of their performance and diversification benefits

Abstract

This thesis employs total return indices to investigate if catastrophe bonds are zero-beta assets and how they have performed compared to other assets. We conduct time series regressions and conclude that catastrophe bond returns are correlated with both the return of the equity- and the high yield corporate bond market during the subprime financial crisis, but find no significant correlation after the crisis. We include a proxy for risk aversion and find that investors’ level of risk aversion affects the correlation during the crisis, something that previous researchers have discussed theoretically but not shown statistically. Using Sharpe ratios, we examine the risk-adjusted return of catastrophe bonds and show that catastrophe bonds noticeably out-performed the equities and the high yield corporate bonds, both during and after the crisis. The high risk-adjusted return, in combination with the low correlation with the other financial markets, make catastrophe bonds an attractive asset to investors.