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Reinsurance demand and liquidity creation: A search for bicausality

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  • Desjardins, Denise
  • Dionne, Georges
  • Koné, N’Golo

Abstract

Our main objective is to establish reciprocal links between reinsurance demand and liquidity creation. Early articles propose that financial institutions enhance economic growth by creating liquidity in the economy. However, liquidity creation exposes firms to liquidity risk because they make themselves illiquid when they create liquidity in the economy. In the insurance industry, unexpected claims can be protected through reinsurance, which introduces a trade-off between the demand for reinsurance and the creation of liquidity. This trade-off can be significant for insurers that have fewer diversification opportunities. Our empirical results, from regularized GMM and ML-SEM estimation methods, show positive bicausal effects between liquidity creation and reinsurance demand for small insurers. The link between the two activities is not significant for large insurers. In all estimations, the standard GMM model is rejected. Our results may have policy implications for liquidity risk management.

Suggested Citation

  • Desjardins, Denise & Dionne, Georges & Koné, N’Golo, 2022. "Reinsurance demand and liquidity creation: A search for bicausality," Journal of Empirical Finance, Elsevier, vol. 66(C), pages 137-154.
    • Handle: RePEc:eee:empfin:v:66:y:2022:i:c:p:137-154
    DOI: 10.1016/j.jempfin.2022.01.005
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    More about this item

    Keywords

    Reinsurance demand; Liquidity creation; Liquidity risk management; Bicausality; GMM; ML-SEM; Policy implication; Insurer regulation;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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