Nondiversification Traps in Catastrophe Insurance Markets

Abstract

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.

The impact of competition on prices with numerous firms

“…Perhaps closest to our paper -and in particular to our finding that markups decrease (increase) with competition for thin-tailed (fat-tailed) distributions -are Weyl and Fabinger Bulow and Klemperer 2002, Dagsvik and Karlstrom 2005, Ibragimov and Walden 2010, Bulow and Klemperer 2012, Weyl and Fabinger 2013, and Armstrong 2015, international trade (e.g., Eaton and Kortum 2002, Bernard, Eaton, Jensen, and Kortum 2003, and Chaney 2008, macroeconomics and growth (e.g., Gabaix 1999, 2011, Jones 2005, Luttmer 2007, and Acemoglu, Carvalho, Ozdaglar, and Tahbaz Salehi 2012, systemic risk analysis (e.g., Jansen and de Vries 1991and Ibragimov, Jaffee, and Walden 2009, 2011 and auction theory (e.g., Hong and Shum 2004. ) 6 In a separate application, Gabaix and Landier (2008) (2013) and Quint (2014), who show how comparative statics of pricing behavior hinge crucially on log-concavity of the demand function; relating this insight to our results, Weyl and Fabinger (2013) point out that competition increases (decreases) markups if the distribution of consumer valuations is log-convex (log-concave).…”

Dependence Patterns Among Banking Sectors in Asia: A Copula Approach

“…The need to understand the relationship between different markets is of broader importance to international diversification, which seeks to minimize the risk of assets through optimal allocation. It is generally accepted that the degree of asset dependence is key to realizing the benefits from international diversification (Samuelson, 1967;Ibragimov, Jaffee, & Walden, 2009;Shin, 2009;Veldkamp and Van Nieuwerburgh, 2010;and Bai and Green, 2010) and markets with high positive dependence do not provide risk reduction benefits to investors.…”

Insuring catastrophes and the role of governments

“…The marginal cost function we use depends on the insurer's cost of capital (which we shall denote k) and its underwriting and claimshandling ability (which we shall denote b). For any of these entities, n, we shall assume that the marginal cost associated with a possible loss of magnitude Y is a linear 2 function (see Froot and O'Connell, 2008;Ibragimov and Walden, 2007;Ibragimov et al, 2009) with two parameters, given by Eq. (1), whereŶ is the maximum possible loss (Y ∈ 0,Ŷ ), and entities in the economy differ with respect to their b n 's and k n 's:…”