Nondiversification Traps in Catastrophe Insurance Markets

We develop a model for markets for catastrophic risk. The model explains why insurance providers may choose not to offer insurance for catastrophic risks and not to participate in reinsurance markets, even though there is a large enough market capacity to reach full risk sharing through diversificat...

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Bibliographic Details
Published in:The Review of financial studies 2009-03, Vol.22 (3), p.959-993
Main Authors: Ibragimov, Rustam, Jaffee, Dwight, Walden, Johan
Format: Article
Language:English
Subjects:
Disaster insurance
Disaster relief
Disasters
Earthquake insurance
Earthquakes
Equilibrium
Financial engineering
Financial risk
Hurricanes
Insurance
Insurance coverage
Insurance industry
Insurance markets
Insurance providers
Investment risk
Mathematical models
Portfolio diversification
Property & casualty insurance
Reinsurance
Risk management
Risk sharing
September 11 terrorist attacks-2001
Statistical methods
Studies
Terrorism
Terrorism insurance
Weapons of mass destruction
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Summary:We develop a model for markets for catastrophic risk. The model explains why insurance providers may choose not to offer insurance for catastrophic risks and not to participate in reinsurance markets, even though there is a large enough market capacity to reach full risk sharing through diversification in a reinsurance market. This is a "nondiversification trap." We show that nondiversification traps may arise when risk distributions have heavy left tails and insurance providers have limited liability. When they are present, there may be a coordination role for a centralized agency to ensure that risk sharing takes place.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhn021