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Combining insurance, contingent debt, and self-retention in an optimal corporate risk financing strategy

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  • Gurenko, Eugene
  • Mahul, Olivier

Abstract

The authors provide a conceptual framework for designing a comprehensive risk financing strategy for a firm, using an optimal combination of three instruments: self-retention, contingent debt, and insurance. Using an original conceptual model, the risk management decisions of the firm are first decomposed into two sets-choosing attachment points for each layer of financing used in the overall risk financing structure, and, then determining optimal risk allocation arrangements within each layer of risk. This model allows the authors to show how these optimal risk financing arrangements are driven by the costs of risk management instruments, the risk characteristics, and the firm's borrowing constraints. Finally, the authors provide an original perspective to think about optimal ex ante risk management strategies, based on a combination of insurance, savings, and credit at the microeconomic or macroeconomic levels.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3167.

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Date of creation: 30 Nov 2003
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Handle: RePEc:wbk:wbrwps:3167

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Keywords: Insurance&Risk Mitigation; Banks&Banking Reform; Financial Intermediation; Payment Systems&Infrastructure; Environmental Economics&Policies; Insurance&Risk Mitigation; Banks&Banking Reform; Financial Intermediation; Environmental Economics&Policies; Insurance Law;

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References

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  1. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, American Finance Association, vol. 48(5), pages 1629-58, December.
  2. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 20(04), pages 391-405, December.
  3. Bruce C. Greenwald & Joseph E. Stiglitz, 1988. "Financial Market Imperfections and Business Cycles," NBER Working Papers 2494, National Bureau of Economic Research, Inc.
  4. Gregory W. Brown & Klaus Bjerre Toft, 2002. "How Firms Should Hedge," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 15(4), pages 1283-1324.
  5. Siegel, Paul B. & Alwang, Jeffrey & Canagarajah, Sudharshan, 2001. "Viewing microinsurance as a social risk management instrument," Social Protection Discussion Papers 23305, The World Bank.
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Cited by:
  1. Victor Cardenas, 2009. "Financiamiento de riesgos catastróficos naturales," Research Department Publications, Inter-American Development Bank, Research Department 4613, Inter-American Development Bank, Research Department.
  2. Gurenko, Eugene & Olivier, Mahul, 2004. "Enabling productive but asset-poor farmers to succeed : A risk financing framework," Policy Research Working Paper Series 3211, The World Bank.
  3. Mahul, Olivier & Gurenko, Eugene, 2006. "The macro financing of natural hazards in developing countries," Policy Research Working Paper Series 4075, The World Bank.
  4. Ghesquiere, Francis & Mahul, Olivier, 2007. "Sovereign natural disaster insurance for developing countries : a paradigm shift in catastrophe risk financing," Policy Research Working Paper Series 4345, The World Bank.

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