IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/25677.html
   My bibliography  Save this paper

The Role of Financial Conditions in Portfolio Choices: The Case of Insurers

Author

Listed:
  • Shan Ge
  • Michael S. Weisbach

Abstract

Many institutional investors depend on the returns they generate to fund their operations and liabilities. How do these investors’ financial conditions affect the management of their portfolios? We address this issue using the insurance industry because insurers are large investors for which detailed portfolio data are available, and can face financial shocks from exogenous weather events that help us establish causality. Among corporate bonds, for which we can control for regulatory treatment, results suggest that when Property & Casualty (P&C) insurers become more constrained due to operating losses, they shift towards safer bonds. The effect of losses on allocations is likely to be causal since it holds when instrumenting for losses with weather shocks. The change in allocations following losses is larger for smaller or worse-rated insurers and during the financial crisis, suggesting that the shift toward safer securities is driven by concerns about financial flexibility. The results highlight the importance of financial conditions in institutional investors’ portfolio decisions.

Suggested Citation

  • Shan Ge & Michael S. Weisbach, 2019. "The Role of Financial Conditions in Portfolio Choices: The Case of Insurers," NBER Working Papers 25677, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:25677
    Note: AP CF
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w25677.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Ricardo J. Caballero & Arvind Krishnamurthy, 2008. "Collective Risk Management in a Flight to Quality Episode," Journal of Finance, American Finance Association, vol. 63(5), pages 2195-2230, October.
    2. Duchin, Ran & Sosyura, Denis, 2014. "Safer ratios, riskier portfolios: Banks׳ response to government aid," Journal of Financial Economics, Elsevier, vol. 113(1), pages 1-28.
    3. Isil Erel & Brandon Julio & Woojin Kim & Michael S. Weisbach, 2012. "Macroeconomic Conditions and Capital Raising," Review of Financial Studies, Society for Financial Studies, vol. 25(2), pages 341-376.
    4. Andrew Ellul & Chotibhak Jotikasthira & Christian T. Lundblad & Yihui Wang, 2015. "Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading," Journal of Finance, American Finance Association, vol. 70(6), pages 2489-2538, December.
    5. Ellul, Andrew & Jotikasthira, Chotibhak & Kartasheva, Anastasia & Lundblad, Christian T. & Wagner, Wolf, 2018. "Insurers as asset managers and systemic risk," ESRB Working Paper Series 75, European Systemic Risk Board.
    6. Almeida, Heitor & Campello, Murillo & Weisbach, Michael S., 2011. "Corporate financial and investment policies when future financing is not frictionless," Journal of Corporate Finance, Elsevier, vol. 17(3), pages 675-693, June.
    7. Zhiguo He & Arvind Krishnamurthy, 2013. "Intermediary Asset Pricing," American Economic Review, American Economic Association, vol. 103(2), pages 732-770, April.
    8. Mayers, David & Smith, Clifford Jr., 1986. "Ownership structure and control : The mutualization of stock life insurance companies," Journal of Financial Economics, Elsevier, vol. 16(1), pages 73-98, May.
    9. Fama, Eugene F & Jensen, Michael C, 1983. "Agency Problems and Residual Claims," Journal of Law and Economics, University of Chicago Press, vol. 26(2), pages 327-349, June.
    10. Divya Kirti, 2017. "When Gambling for Resurrection is Too Risky," IMF Working Papers 2017/180, International Monetary Fund.
    11. Heitor Almeida & Murillo Campello & Igor Cunha & Michael S. Weisbach, 2014. "Corporate Liquidity Management: A Conceptual Framework and Survey," Annual Review of Financial Economics, Annual Reviews, vol. 6(1), pages 135-162, December.
    12. Serdar Çelik & Mats Isaksson, 2014. "Institutional investors and ownership engagement," OECD Journal: Financial Market Trends, OECD Publishing, vol. 2013(2), pages 93-114.
    13. Aleksandar Andonov & Rob M.M.J. Bauer & K.J. Martijn Cremers, 2017. "Pension Fund Asset Allocation and Liability Discount Rates," Review of Financial Studies, Society for Financial Studies, vol. 30(8), pages 2555-2595.
    14. Erik P. Gilje, 2016. "Do Firms Engage in Risk-Shifting? Empirical Evidence," Review of Financial Studies, Society for Financial Studies, vol. 29(11), pages 2925-2954.
    15. Bo Becker & Victoria Ivashina, 2015. "Reaching for Yield in the Bond Market," Journal of Finance, American Finance Association, vol. 70(5), pages 1863-1902, October.
    16. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    17. Assaf Eisdorfer, 2008. "Empirical Evidence of Risk Shifting in Financially Distressed Firms," Journal of Finance, American Finance Association, vol. 63(2), pages 609-637, April.
    18. Ellul, Andrew & Jotikasthira, Chotibhak & Lundblad, Christian T., 2011. "Regulatory pressure and fire sales in the corporate bond market," Journal of Financial Economics, Elsevier, vol. 101(3), pages 596-620, September.
    19. Charles W. Calomiris & Berry Wilson, 2004. "Bank Capital and Portfolio Management: The 1930s "Capital Crunch" and the Scramble to Shed Risk," The Journal of Business, University of Chicago Press, vol. 77(3), pages 421-456, July.
    20. Acharya, Viral V. & Steffen, Sascha, 2015. "The “greatest” carry trade ever? Understanding eurozone bank risks," Journal of Financial Economics, Elsevier, vol. 115(2), pages 215-236.
    21. Zhigu He & Arvind Krishnamurthy, 2012. "A Model of Capital and Crises," Review of Economic Studies, Oxford University Press, vol. 79(2), pages 735-777.
    22. Opler, Tim & Pinkowitz, Lee & Stulz, Rene & Williamson, Rohan, 1999. "The determinants and implications of corporate cash holdings," Journal of Financial Economics, Elsevier, vol. 52(1), pages 3-46, April.
    23. Zhiguo He & Arvind Krishnamurthy, 2018. "Intermediary Asset Pricing and the Financial Crisis," Annual Review of Financial Economics, Annual Reviews, vol. 10(1), pages 173-197, November.
    24. Ellul, Andrew & Jotikasthira, Chotibhak & Lundblad, Christian T & Wang, Yihui, 2015. "Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading," CEPR Discussion Papers 10450, C.E.P.R. Discussion Papers.
    25. Itamar Drechsler & Thomas Drechsel & David Marques-Ibanez & Philipp Schnabl, 2016. "Who Borrows from the Lender of Last Resort?," Journal of Finance, American Finance Association, vol. 71(5), pages 1933-1974, October.
    26. Vayanos, Dimitri, 2004. "Flight to quality, flight to liquidity, and the pricing of risk," LSE Research Online Documents on Economics 456, London School of Economics and Political Science, LSE Library.
    27. Ran Duchin & Thomas Gilbert & Jarrad Harford & Christopher Hrdlicka, 2017. "Precautionary Savings with Risky Assets: When Cash Is Not Cash," Journal of Finance, American Finance Association, vol. 72(2), pages 793-852, April.
    28. Gregor Andrade & Steven N. Kaplan, 1998. "How Costly is Financial (Not Economic) Distress? Evidence from Highly Leveraged Transactions that Became Distressed," Journal of Finance, American Finance Association, vol. 53(5), pages 1443-1493, October.
    29. Girardi, Giulio & Hanley, Kathleen Weiss & Nikolova, Stanislava & Pelizzon, Loriana & Getmansky, Mila, 2018. "Portfolio similarity and asset liquidation in the insurance industry," SAFE Working Paper Series 224, Leibniz Institute for Financial Research SAFE.
    30. Rampini, Adriano A. & Sufi, Amir & Viswanathan, S., 2014. "Dynamic risk management," Journal of Financial Economics, Elsevier, vol. 111(2), pages 271-296.
    31. Parrino, Robert & Weisbach, Michael S., 1999. "Measuring investment distortions arising from stockholder-bondholder conflicts," Journal of Financial Economics, Elsevier, vol. 53(1), pages 3-42, July.
    32. Black, Lamont K. & Hazelwood, Lieu N., 2013. "The effect of TARP on bank risk-taking," Journal of Financial Stability, Elsevier, vol. 9(4), pages 790-803.
    33. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(4), pages 391-405, December.
    34. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. "Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-1658, December.
    35. Joshua D. Rauh, 2009. "Risk Shifting versus Risk Management: Investment Policy in Corporate Pension Plans," Review of Financial Studies, Society for Financial Studies, vol. 22(7), pages 2487-2533, July.
    36. Mohan, Nancy & Zhang, Ting, 2014. "An analysis of risk-taking behavior for public defined benefit pension plans," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 403-419.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Peydró, José Luis & Polo, Andrea & Sette, Enrico, 2020. "Risk Mitigating versus Risk Shifting: Evidence from Banks Security Trading in Crises," CEPR Discussion Papers 15473, C.E.P.R. Discussion Papers.
    2. Divya Kirti, 2017. "When Gambling for Resurrection is Too Risky," IMF Working Papers 2017/180, International Monetary Fund.
    3. Kuersten, Wolfgang & Linde, Rainer, 2011. "Corporate hedging versus risk-shifting in financially constrained firms: The time-horizon matters!," Journal of Corporate Finance, Elsevier, vol. 17(3), pages 502-525, June.
    4. Timmer, Yannick, 2018. "Cyclical investment behavior across financial institutions," Journal of Financial Economics, Elsevier, vol. 129(2), pages 268-286.
    5. Becker, Bo & Opp, Marcus M. & Saidi, Farzad, 2020. "Regulatory Forbearance in the U.S. Insurance Industry: The Effects of Eliminating Capital Requirements," CEPR Discussion Papers 14373, C.E.P.R. Discussion Papers.
    6. Felix Feng, 2018. "Dynamic Compensation under Uncertainty Shocks and Limited Commitment," 2018 Meeting Papers 159, Society for Economic Dynamics.
    7. Felipe S. Iachan, 2020. "Capital Budgeting and Risk Taking Under Credit Constraints," Management Science, INFORMS, vol. 66(9), pages 4292-4314, September.
    8. Lu, Erin P. & Lai, Gene C. & Ma, Qingzhong, 2017. "Organizational structure, risk-based capital requirements, and the sales of downgraded bonds," Journal of Banking & Finance, Elsevier, vol. 74(C), pages 51-68.
    9. (DJ) Fairhurst, Douglas & Liu, Yanguang & Ni, Xiaoran, 2020. "Employment protection and tax aggressiveness: Evidence from wrongful discharge laws," Journal of Banking & Finance, Elsevier, vol. 119(C).
    10. Pryshchepa, Oksana & Aretz, Kevin & Banerjee, Shantanu, 2013. "Can investors restrict managerial behavior in distressed firms?," Journal of Corporate Finance, Elsevier, vol. 23(C), pages 222-239.
    11. Joshua Rauh, 2007. "Risk Shifting versus Risk Management: Investment Policy in Corporate Pension Plans," NBER Working Papers 13240, National Bureau of Economic Research, Inc.
    12. Adriano A. Rampini & S. Viswanathan & Guillaume Vuillemey, 2020. "Risk Management in Financial Institutions," Journal of Finance, American Finance Association, vol. 75(2), pages 591-637, April.
    13. Chia‐Chun Chiang & Greg Niehaus, 2020. "Correlated Trading by Life Insurers and Its Impact on Bond Prices," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 87(3), pages 597-625, September.
    14. Chen, Xuanjuan & Sun, Zhenzhen & Yao, Tong & Yu, Tong, 2020. "Does operating risk affect portfolio risk? Evidence from insurers' securities holding," Journal of Corporate Finance, Elsevier, vol. 62(C).
    15. Efing, Matthias, 2015. "Arbitraging the Basel securitization framework: Evidence from German ABS investment," Discussion Papers 40/2015, Deutsche Bundesbank.
    16. Amiraslani, Hami & Lins, Karl & Servaes, Henri & Tamayo, Ane, 2017. "A Matter of Trust? The Bond Market Benefits of Corporate Social Capital during the Financial Crisis," CEPR Discussion Papers 12321, C.E.P.R. Discussion Papers.
    17. O’ Hara, Maureen & Wang, Yihui & (Alex) Zhou, Xing, 2018. "The execution quality of corporate bonds," Journal of Financial Economics, Elsevier, vol. 130(2), pages 308-326.
    18. Patrick Bolton & Hui Chen & Neng Wang, 2011. "A Unified Theory of Tobin's q, Corporate Investment, Financing, and Risk Management," Journal of Finance, American Finance Association, vol. 66(5), pages 1545-1578, October.
    19. Ye Li, 2018. "Fragile New Economy: The Rise of Intangible Capital and Financial Instability," 2018 Meeting Papers 1189, Society for Economic Dynamics.
    20. Chotibhak, Jotikasthira & Ellul, Andrew & Kartasheva, Anastasia & Lundblad, Christian & Wagner, Wolf, 2018. "Insurers as Asset Managers and Systemic Risk," CEPR Discussion Papers 12849, C.E.P.R. Discussion Papers.

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:25677. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: http://edirc.repec.org/data/nberrus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.