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The Liquidity Demand for Corporate Property Insurance

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  • Arthur Hau
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    Abstract

    This article suggests that liquidity may be an important reason for a corporation to purchase property insurance. A model of a risk-neutral producer facing an endogenously determined risk of property damage under an output contract that penalizes underproduction is formulated to exemplify such a real need of liquidity. Under the output contract, the producer may purchase full unfavorable property insurance even when postloss financing is available. Surprisingly, the conclusion may still hold when the cost of postloss financing equals that of long-term capital, provided that the rate of underproduction penalty is sufficiently high. Similar conclusions apply when postloss financing is replaced by planned internal reserve (self-insurance) that may be invested in the short run at an interest rate that is lower than the long-term cost of capital. When the capital market is perfect, however, the holding of planned internal reserve eliminates the purchase of actuarially unfavorable property insurance. Copyright The Journal of Risk and Insurance, 2006.

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    Bibliographic Info

    Article provided by The American Risk and Insurance Association in its journal Journal of Risk & Insurance.

    Volume (Year): 73 (2006)
    Issue (Month): 2 ()
    Pages: 261-278

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    Handle: RePEc:bla:jrinsu:v:73:y:2006:i:2:p:261-278

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    Cited by:
    1. Erwann Michel-Kerjan & Paul Raschky & Howard Kunreuther, 2011. "Corporate Demand for Insurance: An Empirical Analysis of the U.S. Market for Catastrophe and Non-Catastrophe Risks," NBER Working Papers 17403, National Bureau of Economic Research, Inc.
    2. Joy Jia & Mike Adams & Mike Buckle, 2012. "Insurance and ownership structure in India’s corporate sector," Asia Pacific Journal of Management, Springer, vol. 29(1), pages 129-149, March.
    3. Emilio Venezian, 2009. "Incentive incompatibilities and arbitrage opportunities," Journal of Risk Finance, Emerald Group Publishing, vol. 10(5), pages 422-431, November.

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