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Estimating the Cost of Equity Capital for Insurance Firms With Multiperiod Asset Pricing Models

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  • Alexander Barinov
  • Jianren Xu
  • Steven W. Pottier

Abstract

Previous research on insurer cost of equity (COE) focuses on single‐period asset pricing models. In reality, however, investment and consumption decisions are made over multiple periods, exposing firms to time‐varying risks related to economic cycles and market volatility. We extend the literature by examining two multiperiod models—the conditional capital asset pricing model (CCAPM) and the intertemporal CAPM (ICAPM). Using 29 years of data, we find that macroeconomic factors significantly influence and explain insurer stock returns. Insurers have countercyclical beta, implying that their market risk increases during recessions. Further, insurers are sensitive to volatility risk (the risk of losses when volatility goes up), but not to insurance‐specific risks, financial industry risks, liquidity risk, or coskewness after controlling for other economy‐wide factors.

Suggested Citation

  • Alexander Barinov & Jianren Xu & Steven W. Pottier, 2020. "Estimating the Cost of Equity Capital for Insurance Firms With Multiperiod Asset Pricing Models," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 87(1), pages 213-245, March.
    • Handle: RePEc:bla:jrinsu:v:87:y:2020:i:1:p:213-245
    DOI: 10.1111/jori.12267
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    Cited by:

    1. Farhad Billimoria & Filiberto Fele & Iacopo Savelli & Thomas Morstyn & Malcolm McCulloch, 2021. "On the Design of an Insurance Mechanism for Reliability Differentiation in Electricity Markets," Papers 2106.14351, arXiv.org.
    2. Urbański, Stanisław & Zarzecki, Dariusz, 2022. "The Fama-French model for estimating the cost of equity capital: The impact of real options of investment projects," Economic Systems, Elsevier, vol. 46(1).
    3. Thomas R. Berry-Stölzle & Jianren Xu, 2022. "Local religious beliefs and insurance companies’ risk-taking behaviour," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 47(2), pages 242-278, April.

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