Is the climate-linked CAT bond market efficiently priced? A risk–return analysis

This study offers insights into the catastrophe (CAT) bond market that has the potential to contribute towards further development of this alternative risk transfer product, which can reduce the insurance coverage gap for climate-related catastrophe risk. The study incorporates an econometric analysis, introducing a novel perspective that focuses on assessing the consistency between the (insurance) risk and return ratio for climate-linked CAT bonds that are currently available in the market. This approach verifies if these financial instruments are priced based on the insurance risks they cover. The analysis highlights the presence of market segmentation and provides empirical evidence of pricing inefficiencies, observed as both overpricing and under-pricing across different levels of underlying catastrophic risks. These findings underscore the potential benefits of increased transparency and comprehensive disclosure of market metrics in fostering broader investor participation, including both retail and institutional segments.