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Term structure of discount rates for firms in the insurance industry

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  • Giaccotto, Carmelo
  • Lin, Xiao
  • Zhao, Yanhui

Abstract

There is strong evidence in the literature for the hypothesis that interest rates and the market risk premium are not constant during the business cycle. The beta risk of firms in the insurance industry is also time-varying. The major implication of these results is that discount rates for risky cash flows are time varying and must obey a term structure similar to the term structure of interest rates. The purpose of this paper is to estimate discount rates for cash flows with different time horizons for the U.S. insurance industry and for different insurance sectors. We find that the term structure cost of capital takes on different shapes depending on the business cycle. It is therefore meaningful for insurers to evaluate risky projects by selecting a discount rate most appropriate for the nature and the time horizon of each project.

Suggested Citation

  • Giaccotto, Carmelo & Lin, Xiao & Zhao, Yanhui, 2020. "Term structure of discount rates for firms in the insurance industry," Insurance: Mathematics and Economics, Elsevier, vol. 95(C), pages 147-158.
    • Handle: RePEc:eee:insuma:v:95:y:2020:i:c:p:147-158
    DOI: 10.1016/j.insmatheco.2020.09.004
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    More about this item

    Keywords

    Cost of capital term-structure; Discount rate; Insurance industry; Multi-period CAPM; Conditional CAPM;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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