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Implications of Dynamic Trading for Insurance Markets


  • José S. Penalva


We study the interaction between insurance and capital markets within a single but general framework. We show that capital markets greatly enhance the risk sharing capacity of insurance markets and the scope of risks that are insurable because efficiency does not depend on the number of agents at risk, nor on risks being independent, nor on the preferences and endowments of agents at risk being the same. We show that agents share risks by buying full coverage for their individual risks and provide insurance capital through stock markets. We show that aggregate risk enters private insurance as a positive loading on insurance prices and despite that agents will buy full coverage. The loading is determined by the risk premium of investors in the stock market and hence does not depend on the agent's willingness to pay. Agents provide insurance capital by trading an equally weighted portfolio of insurance company shares and a riskless asset. We are able to construct agents' optimal trading strategies explicitly and for very general preferences.

Suggested Citation

  • José S. Penalva, 2003. "Implications of Dynamic Trading for Insurance Markets," Working Papers 83, Barcelona Graduate School of Economics.
  • Handle: RePEc:bge:wpaper:83

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    References listed on IDEAS

    1. Doherty, N.A. & Dionne, G., 1989. "Risk Pooling, Contract Structure and Organizational Form of Insurance Firms," Cahiers de recherche 8935, Universite de Montreal, Departement de sciences economiques.
    2. Dwight M. Jaffee & Thomas Russell, 1996. "Catastrophe Insurance, Capital Markets and Uninsurable Risks," Center for Financial Institutions Working Papers 96-12, Wharton School Center for Financial Institutions, University of Pennsylvania.
    3. Doherty, Neil A & Schlesinger, Harris, 1983. "Optimal Insurance in Incomplete Markets," Journal of Political Economy, University of Chicago Press, vol. 91(6), pages 1045-1054, December.
    4. K. J. Arrow, 1964. "The Role of Securities in the Optimal Allocation of Risk-bearing," Review of Economic Studies, Oxford University Press, vol. 31(2), pages 91-96.
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    More about this item


    full insurance; risk sharing; portfolio choice; welfare; hetrogeneity;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • 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
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty


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