A contingent claim model of life insurer-bank swap default pricing: strategic substitutes and complements

Jyh-Horng Lin, Shi Chen and Fu-Wei Huang

Applied Economics, 2021, vol. 53, issue 36, 4166-4177

Abstract: This paper develops a contingent claim framework to examine swap transactions between a life insurer and a bank that bilaterally price default risks. We show that the insurer (the protection buyer in the swap transaction market) regards the optimal bank loan rate as a strategic complement. In contrast, the bank (the protection seller) considers the optimal insurer guaranteed rate as a strategic substitute. Hedging conducted by the insurer enhances profits but hurts policyholder protection. Bank capital regulation harms policyholder protection. Insurer capital regulation leads to bank risk-taking. Capital regulations, as such, would jeopardize insurer-bank performance from a financial stability standpoint.

Date: 2021
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DOI: 10.1080/00036846.2021.1897077

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