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Why have exchange-traded catastrophe instruments failed to displace reinsurance?


Gibson, Rajna; Habib, Michel; Ziegler, Alexandre (2007). Why have exchange-traded catastrophe instruments failed to displace reinsurance? NCCR FINRISK Working Paper Series 371, University of Zurich.

Abstract

In spite of the fact that they can draw on a larger, more liquid and more diversiedpool of capital than the equity of reinsurance companies, nancial markets have failedto displace reinsurance as the primary risk-sharing vehicle for natural catastropherisk. We show that this failure can be explained by dierences in information gatheringincentives between nancial markets and reinsurance companies. Using a simple modelof an insurance company that seeks to transfer a fraction of its risk exposure eitherthrough nancial markets or through traditional reinsurance, we nd that the supplyof information by informed traders in nancial markets may be excessive relative to itsvalue for the insurance company, causing reinsurance to be preferred. We show thatwhether traditional reinsurance or nancial markets are ultimately selected dependscrucially on the information acquisition cost structure and on the degree of redundancyin the information produced. Limits on the ability of informed traders to protablytake advantage of their information make the use of nancial markets more likely.

In spite of the fact that they can draw on a larger, more liquid and more diversiedpool of capital than the equity of reinsurance companies, nancial markets have failedto displace reinsurance as the primary risk-sharing vehicle for natural catastropherisk. We show that this failure can be explained by dierences in information gatheringincentives between nancial markets and reinsurance companies. Using a simple modelof an insurance company that seeks to transfer a fraction of its risk exposure eitherthrough nancial markets or through traditional reinsurance, we nd that the supplyof information by informed traders in nancial markets may be excessive relative to itsvalue for the insurance company, causing reinsurance to be preferred. We show thatwhether traditional reinsurance or nancial markets are ultimately selected dependscrucially on the information acquisition cost structure and on the degree of redundancyin the information produced. Limits on the ability of informed traders to protablytake advantage of their information make the use of nancial markets more likely.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2007
Deposited On:19 Mar 2012 09:50
Last Modified:05 Apr 2016 15:37
Series Name:NCCR FINRISK Working Paper Series
Free access at:Related URL. An embargo period may apply.
Official URL:http://www.zora.uzh.ch/59116
Related URLs:http://www.nccr-finrisk.uzh.ch/media/pdf/wp/WP371_B1,%20C1.pdf
Other Identification Number:merlin-id:6754
Permanent URL: https://doi.org/10.5167/uzh-59116

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