Reinsurance or Securitization:The Case of Natural Catastrophe Risk

We investigate the suitability of securitization as an alternative to reinsurance forthe purpose of transferring natural catastrophe risk. We characterize the conditionsunder which one or the other form of risk transfer dominates using a setting in whichreinsurers and traders in financial markets produce costly information about catastrophes.Such information is useful to insurers: along with the information produced byinsurers themselves, it reduces insurers’ costly capital requirements. However, traderswho seek to benefit from trading in financial markets may produce ‘too much’ information.This instance of the Hirshleifer effect may make risk transfer throughsecuritization prohibitively costly.