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Evolutionary Portfolio Selection with Liquidity Shocks

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  • Enrico De Giorgi

    ()
    (University of Zurich)

Abstract

Insurance companies invest their wealth in financial markets. The wealth evolution strongly depends on the success of their investment strategies, but also on liquidity shocks which occur during unfavourable years, when indemnities to be paid to the clients exceed collected premia. An investment strategy that does not take liquidity shocks into account, exposes insurance companies to the risk of bankruptcy, when liquidity shocks and low investment payoffs jointly appear. Therefore, regulatory authorities impose solvency restrictions to ensure that insurance companies are able to face their obligations with high probability. This paper analyses the behaviour of insurance companies in an evolutionary framework. We show that an insurance company that merely satisfies regulatory constraints will eventually vanish from the market. We give a more restrictive no bankruptcy condition for the investment strategies and we characterize trading strategies that are evolutionary stable, i.e. able to drive out any mutation. We study the existence of such strategies and the conditions under which financial and insurance markets are stable.

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 15.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:15

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Keywords: insurance; portfolio theory; evolutionary finance.;

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  19. Davis, E. Philip, 2002. "Prudent person rules or quantitative restrictions? The regulation of long-term institutional investors' portfolios," Journal of Pension Economics and Finance, Cambridge University Press, vol. 1(02), pages 157-191, July.
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Cited by:
  1. Bruno S. Frey & Simon Luechinger & Alois Stutzer, 2004. "Calculating Tragedy: Assessing the Costs of Terrorism," CREMA Working Paper Series 2004-23, Center for Research in Economics, Management and the Arts (CREMA).

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