I first heard about catastrophe bonds (cutely named “cat” bonds) from a tweet by (perhaps my favorite) author.
I proceeded to do some light research on cat bonds, before dropping the subject. But recent events bring me back to the topic.
Unfortunately the property where I was staying took some damages as a result of hurricane winds. Which may be why the following article caught my attention.
With damage estimates for Hurricane Irma tumbling, investors in "cat bonds" will likely avoid the significant losses…www.wsj.com
First off, I was unaware of the size of the cat bond market ($26 billion outstanding). In addition, it makes sense that there exists a large variety of “triggers” tied to the different tranches of these bonds (discussed in the article). The exposures covered include “meteorite strikes” and “solar flares”, which brings to my mind the funny (and impractical) thoughts of cat bonds insuring against a 2012-type series of events, or the possibility of buying cat bonds issued by doomsday cults.
Lack of Reflexivity?
But the more interesting idea here, that separates cat bonds from, say, other event-focused fixed income products like single-name CDS, is that the market activity has no bearing on the probability of the event in question. Stock or bond investors may be spooked by speculative activity in the corresponding CDS market, and be spurred to take action (read: sell), damaging the financial condition of the reference entity, which further increases the odds of default in a self-reinforcing fashion. But weather patterns have no discernible relationship to the activity in the cat bond market, or any insurance market for that matter. Unless an investor is somehow in possession of a tsunami or earthquake machine.
Given the illiquidity and esoteric risks of cat bonds, coupled with a perhaps under-qualified investor base, this may create opportunities for (1) people who have a good-enough market sense (and guts) to step in at the right moment, and / or (2) people who believe they are better at playing the weatherman, even if the forecasting period is short (a few days in advance).
Which may be why Nassim Taleb was (is?) looking at cat bonds in the first place.