 Pure risk, agency conflict, and hedgingLu Chen, Bingqing Li and Wenyuan Zheng Journal of Banking & Finance, 2024, vol. 168, issue C Abstract: This study develops a theoretical model to analyze the asset substitution problem over insurance decisions. We find that agency conflict is related to a firm’s risk level and capital structure. In particular, at the optimal leverage, agency conflict occurs only when the risk level is relatively high, which explains why insurance covenants are typically for significant pure risks. Moreover, when the risk level is specified, agency conflict over insurance decisions occurs within a specific leverage range. This is consistent with the findings of some research on the asset substitution problem over speculative risk choices. In addition, we consider premium loadings and conclude that full hedging is not a firm’s optimal risk management strategy, contributing to the literature on optimal hedging decisions with transaction frictions. Our framework with premium loadings can also explain many insurance phenomena, such as risk retention for small losses and subsidies for catastrophe insurance. Keywords: Asset substitution problem; Asset risk choice; Hedging decision; Structural model (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:168:y:2024:i:c:s0378426624002085 DOI: 10.1016/j.jbankfin.2024.107294 Access Statistics for this article Journal of Banking & Finance is currently edited by Ike Mathur More articles in Journal of Banking & Finance from Elsevier |
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