Insurers as asset managers and systemic risk
Christian T. Lundblad and
Wolf Wagner ()
No 75, ESRB Working Paper Series from European Systemic Risk Board
Financial intermediaries often provide guarantees that resemble out-of-the-money put options, exposing them to tail risk. Using the U.S. life insurance industry as a laboratory, we present a model in which variable annuity (VA) guarantees and associated hedging operate within the regulatory capital framework to create incentives for insurers to overweight illiquid bonds (“reach-for-yield”). We then calibrate the model to insurer-level data, and show that the VA-writing insurers’ collective allocation to illiquid bonds exacerbates system-wide fire sales in the event of negative asset shocks, plausibly erasing up to 20-70% of insurers’ equity capital. JEL Classification: G11, G12, G14, G18, G22
Keywords: financial stability; insurance companies; inter-connectedness; systemic risk (search for similar items in EconPapers)
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Working Paper: Insurers as Asset Managers and Systemic Risk (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:srk:srkwps:201875
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