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Evolutionary Portfolio Selection with Liquidity Shocks

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  • Enrico De Giorgi

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 au- thorities impose solvency restrictions to ensure that insurance companies are able to face their obligations with high probability. This paper analyses the behaviour of in- surance 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.

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Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 185.

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Handle: RePEc:zur:iewwpx:185

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Keywords: insurance; portfolio theory; evolutionary finance;

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  2. Paul Embrechts, 1996. "Actuarial versus Financial Pricing of Insurance," Center for Financial Institutions Working Papers 96-17, Wharton School Center for Financial Institutions, University of Pennsylvania.
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Cited by:
  1. Bruno S. Frey & Simon Luechinger & Alois Stutzer, 2004. "Calculating Tragedy: Assessing the Costs of Terrorism," CESifo Working Paper Series 1341, CESifo Group Munich.

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