Who Says Catastrophe Bond Payouts Are Not Correlated With The Stock Market?

Here is some food for thought:  Catastrophe bond payouts are correlated with climate change.  Climate change is correlated with stock market returns.  Therefore catastrophe bond payouts are correlated with the stock market.   See Aristotle, Prior Analytics.  We did not study philosophy but Aristotle’s syllogism seems difficult to refute.

The March 2013 Best’s Review reports on investors’ current heightened interest in catastrophe bonds; demand in 2012 was up 37% over the previous year and was the second highest level ever.  See Ron Panko, Behind the Cat Bond Surge, Best’s Review 56 (March 2013).   The “allure of cat bonds” is four-fold:

1.  “They are one of the few assets that are uncorrelated to the broader financial markets.”
2. Their return can be very strong (although if the bond is triggered its investors can lose everything).
3. They are liquid.
4. They are trackable against an index.  

It doesn’t take a lot of insight to note that all of these factors but the first are common to many things investors put their money into.  So the interest in cat bonds is fundamentally the idea that they are not correlated with the stock market.  When the market goes up, down or sideways, cat bond values pay no heed.

The article then provides some interesting data concerning the perils considered by 2012’s catastrophe bonds for property and casualty related risks:  earthquakes, hurricanes, severe thunderstorms, winter storms, and wildfires.  It does not take a climate scientist to notice that four of the five perils are perils exacerbated by climate change.  If one tallies up the 26 transactions, 22 of them consider a climate-related risk (albeit 8 of those also consider earthquakes).  The major premise is satisfied:  catastrophe bond payouts correlate with climate change.

We figured documenting the financial impact of climate change would be easy.  It was.  As scientist Adam Frank put it on NPR:

“Like it or not, the climate system is the underpinning of the economic system. Production and trade do not occur in a vacuum. They occur in the real world of soil and oceans, rainfall and atmospheric flows. Our most basic economic assumptions — the foundations of our way of life — are challenged when the conditions in this real world change.”  

As an example he cited a noted liberal, left-wing, environmentalist publication – the Wall Street Journal – which covered the effects of last year’s drought:  $8 billion in gross domestic product lost.  Archer Daniel Midland’s stock price last summer was not pretty to look at.  Neither was Tyson Foods’.  Thus, and assuming the drought  was caused or aggravated by climate change, the minor premise is satisfied.

Therefore, the conclusion, catastrophe bond payouts are correlated with the stock market, is established.  We realize this flies in the face of conventional wisdom.  The effects of climate change have a tendency to do that.

 

Topics:  Catastrophe Bonds, Climate Change, Investors, Stocks

Published In: Environmental Updates, Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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