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Comment by rrjjww | Hacker News Reader

The lack of information was my inspiration for building Riskvest. I called my own broker and when I said catastrophic bonds they asked if I meant buying bonds already in default.

On the risk side - your comments here are part of the myth I’m trying to dispel and will have lots more to say in future posts.

Yes for a single CAT bond you are exposed to potential 100% principle losses. But if you buy a bundle of CAT bonds that focus on say California Earthquake, Florida Hurricane, Japanese Typhoon, and a Cyber Event, you can imagine the diversification benefit you get there.

I’ve already created a very very simple model for people to play around with and learn the intuition for CAT bond return patterns. A default means 100% loss and this is unique vs. other bonds. I plan in the future to build a much more robust model.

https://www.riskvest.io/data-lab/cat-bond-portfolio-simulato...

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With the way things are going with climate change, I think that assuming “extreme climate events in different geographies are independent statistical events” is an extremely flawed assumption to make. You acknowledge that it is a simplified model, but that is not some minor oversight. Any model that does not account for this is deeply flawed, and I think no insurance company would choose to model extreme event risk like that. There are common factors (e.g. global average temperature) that can cause many of these events to be triggered in a correlated way.

A “2% risk of default” on an individual bond is something a retail investor might be able to understand, but no one should be buying a “diversified” bundle of these things if they cannot form a reasonable understanding of how correlated they are. Why should understanding the correlation risk be left up to individual investors building their own portfolios?

I also think forming an intuition for these more “all-or-nothing” type events is more difficult than e.g. understanding that if GOOG goes down 10% then AAPL might do too at the same time because they are both tech stocks.

> But if you buy a bundle of CAT bonds that focus on say California Earthquake, Florida Hurricane, Japanese Typhoon, and a Cyber Event, you can imagine the diversification benefit you get there.

Yeah, but imagine how bad a day you're having if all of those disasters happen at once, and then as a cherry on top you lose all your money.

Yeah, it seems like you’d want to buy bonds that covers areas that you’re not personally in…

Why? It's not like you can influence the trigger of any such catastrophe

Same principle as why many people prefer not to own shares in the company that employs them -- you're already heavily exposed to that specific risk and don't want to add more. If you live in Florida then a hurricane in Florida already might mean financial loss for you if it damages your house, so buying a CAT bond that covers a different thing is more diversified risk: you might get "house is trashed" or "bond is total loss" but at least you probably will not get both at once.

I understand, it's risk diversification.

You're not incorrect, but this is the same sort of risk you take when buying an index fund, just that index funds have 100x more entries, so are much more diversified. Eg, we could rewrite this about an index fund like:

"Yeah, but imagine how bad a day you're having if all of those [stocks drop] at once, and then as a cherry on top you [enter a recession]."

I'm not saying this is exactly like buying an index fund. I'm very un-knowledgable about CAT bonds. I'm just saying that your criticism holds for _every_ diversified bundle of risks.

It’s almost like we should have bundled all these bonds as a product instead of selling single bonds.

And then we can take a bunch with correlated risk, pretend it isn't correlated, and sell it as a lower risk product!

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