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Derivatives and corporate risk management: participation and volume decisions in the insurance industry

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  • J. David Cummins
  • Richard D. Phillips
  • Stephen D. Smith

Abstract

In this paper we formulate and test a number of hypotheses regarding insurer participation and volume decisions in derivatives markets. Several specific hypotheses are supported by our analysis. We find evidence consistent with the idea that insurers are motivated to use financial derivatives to hedge the costs of financial distress, interest rate, liquidity, and exchange rate risks. We also find some evidence that insurers use these instruments to hedge embedded options and manage their tax bills. We also find evidence of significant economies of scale in the use of derivatives. Interestingly, we often find that the predetermined variables we employ display opposite signs in the participation and volume regressions. We argue that this result is broadly consistent with the hypothesis that there is also a per unit premium associated with hedging and that, conditional on having risk exposures large enough to warrant participation, firms with a larger appetite for risk will be less willing than average to pay this marginal cost.

Suggested Citation

  • J. David Cummins & Richard D. Phillips & Stephen D. Smith, 1997. "Derivatives and corporate risk management: participation and volume decisions in the insurance industry," FRB Atlanta Working Paper 97-12, Federal Reserve Bank of Atlanta.
  • Handle: RePEc:fip:fedawp:97-12
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    References listed on IDEAS

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    Cited by:

    1. Sinha, Pankaj & Sharma, Sakshi, 2016. "Derivative use and its impact on Systematic Risk of Indian Banks: Evidence using Tobit model," MPRA Paper 72251, University Library of Munich, Germany.
    2. Cummins, J. David & McDonald, James B. & Merrill, Craig, 2007. "Risky Loss Distributions and Modeling the Loss Reserve Pay-out Tail," Review of Applied Economics, Review of Applied Economics, vol. 3(1-2).
    3. Benjamin Lorent, 2006. "Raisons fondamentales d'une régulation prudentielle du secteur des assurances," Brussels Economic Review, ULB -- Universite Libre de Bruxelles, vol. 49(3), pages 203-244.
    4. Zainal Abidin, Fazlini, 2017. "The Impact Of Corporate Environmental Performance Of Market Risk On Tropicana Corporation Berhad," MPRA Paper 78620, University Library of Munich, Germany.
    5. Gatzert, Nadine, 2008. "Asset management and surplus distribution strategies in life insurance: An examination with respect to risk pricing and risk measurement," Insurance: Mathematics and Economics, Elsevier, vol. 42(2), pages 839-849, April.
    6. Sojung Carol Park & Jean Lemaire & Xiaoying Xie, 2016. "The Opaqueness of Structured Bonds: Evidence from the U.S. Insurance Industry," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 41(4), pages 650-676, October.
    7. J. Cummins & Georges Dionne & Robert Gagné & A. Nouira, 2009. "Efficiency of insurance firms with endogenous risk management and financial intermediation activities," Journal of Productivity Analysis, Springer, vol. 32(2), pages 145-159, October.
    8. Atsushi Takao & I Wayan Nuka Lantara, 2009. "The Determinants Of The Use Of Derivatives In Japanese Insurance Companies," Discussion Papers 2009-38, Kobe University, Graduate School of Business Administration.
    9. Frank H. Bezzina & Simon Grima, 2012. "Exploring factors affecting the proper use of derivatives: An empirical study with active users and controllers of derivatives," Managerial Finance, Emerald Group Publishing, vol. 38(3), pages 414-435, March.
    10. Danijela Miloš Sprcic, 2007. "The Derivatives as Financial Risk Management Instruments: The Case of Croatian and Slovenian Non-financial Companies," Financial Theory and Practice, Institute of Public Finance, vol. 31(4), pages 395-420.
    11. Joy Jia & Mike Adams & Mike Buckle, 2012. "Insurance and ownership structure in India’s corporate sector," Asia Pacific Journal of Management, Springer, vol. 29(1), pages 129-149, March.
    12. Kenneth A. Froot, 2007. "Risk Management, Capital Budgeting, and Capital Structure Policy for Insurers and Reinsurers," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 74(2), pages 273-299.
    13. Selim Mankaï & Aymen Belgacem, 2013. "Interactions Between Risk-Taking, Capital, and Reinsurance for Property-Liability Insurance Firms," EconomiX Working Papers 2013-23, University of Paris Nanterre, EconomiX.
    14. Fernando Rubio, 2004. "Eficiencia Simple Del Mercado De Renta Fija En Chile," Finance 0405009, EconWPA.

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