Financial Sector Stress and Risk Sharing: Evidence from the Weather Derivatives Market

Abstract

I examine the effect of financial sector stress on risk sharing in a novel setting: the CME’s weather derivatives market. The structure of the market allows me to disentangle price movements due to financial sector stress from price movements due to fundamentals. Contracts, which are typically priced near their actuarially fair value, experience significant price declines during periods of financial sector stress. Contracts with greater margin requirements and total risk are the most affected. The results provide causal evidence of the effect of financial sector stress on the pricing of exchange-traded financial contracts and risk sharing in the economy. Received July 21, 2017; editorial decision July 22, 2018 by Editor Philip Strahan. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.