Title: Economic Catastrophe Bonds: Inefficient Market or Inadequate

Model?

Time: 10:00-11:30am on Nov. 25, Friday

Place: Room 215, New Building of the Guanghua School of Management

Speaker: Haitao LI, Jack D. Sparks-Whirlpool Corp Research Professor of

Finance

Stephen M. Ross School of Business，University of Michigan

Abstract: In an influential paper, Coval, Jurek and Stafford (2009, CJS hereafter) argue that senior CDX tranches resemble economic catastrophe bonds–“bonds that default only under severe economic conditions.” Based on a Merton structural model under the CAPM framework, CJS claim that senior CDX tranches are overpriced relative to S&P 500 index options and do not sufficiently compensate investors for their inherent economic catastrophe risks. In this paper, we show that the conclusion of CJS that senior CDX tranches are overpriced is due to their problematic calibration procedure and restrictive model assumptions. On the other hand, we show that a simple and more parsimonious model proposed by Hull and White (2004) can price CDX tranches well. As a result, it is difficult to conclude that CDX tranches are mispriced simply because the CJS model cannot price them.

Bio:

Professor Li's current research interests are in theoretical and empirical asset pricing, term structure of interest rates, hedge funds, and financial econometrics. His recent works have developed econometric methods for analyzing continuous-time finance models driven by jump diffusions and Levy processes using underlying and derivative prices. He has developed and tested multi-factor term structure models for pricing and hedging interest rate derivatives and options embedded in corporate bonds. He has also developed asset pricing tests in absence of arbitrage and applied them to evaluate hedge fund returns. Professor Li has published in the Journal of Finance, the Journal of Financial Economics, the Review of Finance Studies, the Journal of Econometrics, and other finance and economics journals. Professor Li received the Sterling Prize Fellowship from Yale University, the Trefftz Award from the Western Finance Association, and a research grant from the Q-group.