Abstract
This paper examines the impact of the hurricane season 2005, in particular hurricane Katrina, on the pricing of CAT bonds. In doing so, we examine whether highly rated CAT bonds compared to sub-investment bonds show a different relation between objective risk measures and the spread. The theoretical framework for this relationship is based on the Lance Financial (LFC) model introduced by Lane (2003). The empirical results of treed Bayesian estimation confirm that the severity component of the spread has an increased impact, indicating a shift in the perception of investors during the pricing process. While the impact of the conditional expected loss significantly increases, it contributes through its interaction with the attachment probability, however, not through the variance. Finally, we show that the influence of conditional expected loss is also increased by investment grade ratings, since investors who demand highly rated bonds may be more concerned about possible losses than junk bond investors.
Published Version
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