Do investors reward sovereign catastrophe bond issuance? Evidence from a panel of 26 disaster-prone countries

Abstract

There is extensive evidence in the literature that countries confronted with higher exposure to natural disasters are faced with higher sovereign borrowing costs, as investors request a risk premium to offset disaster risk. On the other hand, market participants may salute efforts by governments to reduce their financial exposure to natural disaster events. This paper makes several contributions to the existing literature. It is the first to investigate whether investors view disaster-prone countries more favorably when they issue sovereign catastrophe (CAT) bonds as a means to mitigate the risks associated with natural catastrophes. Through the use of a feasible generalized least squares model and data from 26 countries spanning from 2000 to 2022, I find that the issuance of sovereign CAT bonds leads to a reduction in long-term sovereign bond yields ranging from 0.79 to 1.88 percentage points on average depending on the model specification used. Furthermore, partitioning the sample into OECD and non-OECD members reveals that the magnitude of this impact is more pronounced in the former group. Additionally, issuing CAT bonds is shown to compress the spread between yields on 10-year sovereign bonds and 3-month Treasury bills by an average of 1.98 percentage points. Other important findings are that the effects of CAT bond issuance are heightened in countries with more developed financial markets and higher levels of carbon dioxide emissions.