Abstract
We propose exact exogeneity tests and weak-instruments-robust tests on factor loadings for a system of regressions with possibly non-Gaussian disturbances. Our methodology is valid in finite samples and accounts for common cross-sectional factors. Analytical invariance results are derived, with companion simulation studies. Finally, a total-effect parameter is introduced that embeds the unobservable endogeneity factor. Proposed tests are applied to assess whether Catastrophe bond mutual funds co-move with financial markets. Significant risk premiums are detected globally and over time, although they are less pervasive from a domestic currency perspective. Findings underscore the importance of instrumenting and assessing direct and total effects.
Notes
1 See Anderson and Rubin (Citation1949).
2 See Durbin (Citation1954), Wu (Citation1973), Hausman (Citation1978).
3 A general definition of a block of simultaneous equations is given by Anderson (Citation2006).
4 In 2017 for example, $30 billion USD of CBs were outstanding with a nearly 60% share of all new bond issues captured by CBMFs (Aon Benfield, Citation2017a; Artemis, Citation2017). In addition, CBs accounted for nearly 30% of global funding of property catastrophe reinsurance obtained from alternative channels (Aon Benfield, Citation2017b).
5 We used a similar argument in the Appendix to prove invariance. Here we also need to recall that
6 n = 25 or 49 correspond to common applications with Fama-French portfolios in asset pricing.
7 Our paper does not aim to take a stand on pandemic bonds specifically but the bonds and funds we study cover extreme mortality and life risks.
8 For instance, in a low interest rate environment investors” reaching for the yield” may find CBMFs that offer attractive returns more appealing. Investors may be also more interested in CBMFs with a riskier composition. Reinsurance companies are also subject to systematic risks.
9 The division into sub-periods is based on dates from the National Bureau of Economic Research.
10 Descriptive statistics are reported in the Appendix.
11 As a robustness check, we used VWRETD expressed in foreign currency, along with the same exchange rates as described above. Results reveal no change in our empirical evidence using that alternative.