Working Papers
Hedging through Product Design (with Ishita Sen)
We document a large shift in the market for market risk insurance. Traditionally, insurers sell market risk protection to households via retirement savings products with minimum return guarantees. Frictions in hedging aggregate risk means insurers retain risk exposures inducing financial fragility. Over the last few years, insurance companies have sold more than $200Bn in long-dated short put products, effectively buying downside risk protection from households. Protection flows from households with the greatest risk bearing capacity to insurers that are most constrained. We show how hedging in the product markets has large advantages over hedging in financial markets and improves the financial stability of the insurance sector. We discuss implications for pricing, hedging, asset allocation and the allocation of aggregate risk in the economy
Procyclical Asset Management and Bond Risk Premia (with Christoph Fricke and Emanuel Moench)
Deutsche Bundesbank Discussion Paper, ESRB Discussion Paper, VoxEU Column, In Press
We use unique institutional securities holdings data to examine the trading behaviour of delegated institutional capital and its impact on bond risk premia. We show that institutional fund managers trade strongly procyclically: they actively move into higher yielding, longer duration and lower rated securities as yields fall and spreads compress, and vice versa. Funds more exposed to negative yields increase their risk-taking more strongly, and this effect is particularly pronounced for those offering explicit minimum return guarantees. Institutional funds' investments have large and persistent price impact in both corporate and sovereign bond markets. We provide evidence that this procyclical behaviour is driven by career concerns among institutional fund managers.
Presented at: BIS, Bundesbank Spring Conference, Copenhagen Business School, ECB, European Economic Association, ESSEC, Frankfurt School of Finance, St Gallen, Swiss Winter Conference in Financial Intermediation, Transatlantic Doctoral Conference, Vienna University, Western Economic Association
Inconsistent Capital Regulation (update coming soon!)
We use the transition in January 2016 from the Solvency I regulatory regime, which was heterogenous across countries in the European Union (EU), to the Solvency II regime, which harmonizes insurance regulation across countries, to understand the impact of heterogenous insurance regulation on cross-country variation in product market outcomes and financial stability. Using variation across insurers within the same country, and across countries for the same insurance group, we show that market risk insurance via guaranteed return products is more prevalent in countries with more lax capital requirements. Moreover, we show that the interest rate exposure of insurance companies increased as interest rates declined in recent years, and this effect is more pronounced for companies with a larger share of guaranteed return products. We conclude by discussing potential determinants of differences in cross-country regulation related to pension systems, salient historical events such as insurance company failures, and political incentives to stimulate the growth of insurance markets.