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Risk Management, Capital Budgeting, and Capital Structure Policy for Insurers and Reinsurers

Kenneth Froot

Journal of Risk & Insurance, 2007, vol. 74, issue 2, 273-299

Abstract: This article builds on Froot and Stein in developing a framework for analyzing the risk allocation, capital budgeting, and capital structure decisions facing insurers and reinsurers. The model incorporates three key features: (i) value‐maximizing insurers and reinsurers face product‐market as well as capital‐market imperfections that give rise to well‐founded concerns with risk management and capital allocation; (ii) some, but not all, of the risks they face can be frictionlessly hedged in the capital market; and (iii) the distribution of their cash flows may be asymmetric, which alters the demand for underwriting and hedging. We show these features result in a three‐factor model that determines the optimal pricing and allocation of risk and capital structure of the firm. This approach allows us to integrate these features into: (i) the pricing of risky investment, underwriting, reinsurance, and hedging; and (ii) the allocation of risk across all of these opportunities, and the optimal amount of surplus capital held by the firm.

Date: 2007
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Citations: View citations in EconPapers (59)

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https://doi.org/10.1111/j.1539-6975.2007.00213.x

Related works:
Working Paper: Risk Management, Capital Budgeting and Capital Structure Policy for Insurers and Reinsurers (2003) Downloads
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