Do Sovereign Catastrophe Bonds Improve Fiscal Resilience? An Application of Synthetic Control Method to Mexico

Abstract

Abstract Natural disasters exert a significant impact on government finances. Catastrophe bonds (CAT bonds) constitute risk-transfer instruments that could help governments improve their fiscal resilience when catastrophic events occur. However, given the very limited issuance of sovereign CAT bonds so far, their actual impact on fiscal resilience is difficult to quantify. There is no literature on this topic currently available. I attempt to fill this gap and assess the impact of CAT bond payouts on the fiscal balance of the Mexican government using the synthetic control method. As an early adopter and repeated issuer of sovereign CAT bonds since 2006, Mexico received its first CAT bond payout in 2017. The payout was triggered by a high-magnitude earthquake that stroke the country in September 2017, with an estimated impact of 0.24% of Mexico’s gross domestic product (GDP). I identify 12 countries that experienced natural disasters with a similar impact on GDP in 2017, but which unlike Mexico have not received a CAT bond payout that year. I then compare post-2017 fiscal balances for Mexico with a synthetic control unit that combines the characteristics of the 12 similar but untreated countries, while controlling for other factors that could have had an impact on this fiscal variable. I find a positive impact of the 2017 CAT bond payout on the evolution of Mexico’s fiscal balance compared to its synthetic control unit. JEL classification: C22; C54; G23; G32; H63; H68