Catastrophic (CAT) Bond as Sustainable Finance Instruments: Understanding from Cross-Country Perspectives

Abstract

Disasters have significant environmental, human, social, economic, and financial impacts. These effects are potentially long-lasting and have multi-generational consequences. Due to climate change, disasters have cascading and compound effects, heightening the financial risks. However, the number of countries issuing CAT Bonds as a financial instrument for tackling the financial burden of disasters is less than 5% as of 2023. This study explores the need to use CAT Bonds as a risk transfer mechanism that allows governments and insurers to spread their climate change risk across capital markets. It presents a comprehensive cross-country level analysis of the potential drivers that influence the CAT bond issuance at a sovereign level for 131 countries from 2016 to 2021 to understand their significance for issuers and non-issuers of CAT Bonds. These potential drivers were filtered after an exploratory factor analysis. Nonetheless, the imbalance between the number of issuers and non-issuers has resulted in poor classification accuracy results and bias. Hence, this study employs Logistic Regression with Synthetic Minority Over-sampling Technique (SMOTE) and without SMOTE. Further, a comparison study between the effective CAT Bond issuance in the Philippines against non-issuance in India was conducted to determine the obstacles in the Indian setting. The result from the study indicates that a country’s exposure to hazards, population growth, investment freedom, regulatory quality, gross budget balance, stock traded and rule of law have statistically significant impact on the issue of CAT Bond. Highlighting the Indian context, the major challenges the country faces in issuing CAT Bonds are its stringent rule of law, regulatory inferiority, economic uncertainty, and less stock traded.