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On the cost‐of‐capital rate under incomplete market valuation

Hansjörg Albrecher, Karl‐Theodor Eisele, Mogens Steffensen and Mario V. Wüthrich

Journal of Risk & Insurance, 2022, vol. 89, issue 4, 1139-1158

Abstract: In this paper we discuss the concept of the cost‐of‐capital (CoC) rate for an insurance company as an equilibrium in the economic triangle of policyholders, shareholders, and the regulator. This provides a possible rationalization and an economic foundation for a quantity that is widely used in practice but whose value is typically neither technically nor economically well justified. We show how it can be well founded in such a triangular equilibrium. Under a simple one‐period model and a valuation procedure of a two‐price economy for illiquid assets we provide a corresponding economic‐theoretical quantification for the CoC rate. The resulting rates are illustrated by a number of concrete numerical examples.

Date: 2022
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