Insurers Use Banks for Portfolio Diversification (Job Market Paper) (Link)
Insurance companies hold a significant share of the financial sector's long-term bond debt ("finance bonds"). Yet, little is known about the determinants of insurers' investment in finance bonds. Using detailed regulatory data on US insurers, I document that small insurers invest disproportionately in finance bonds. As insurers grow, they extend their portfolios to other industries and eventually underweight finance bonds relative to the market. Exploiting a regulatory reform in 2017 that extended insurers' access to bond exchange-traded funds, I show that finance bonds became less attractive to small insurers. This suggests that finance bonds are an implicit means of diversification, especially for small insurers. I develop a model that rationalizes these observations as the outcome of insurers' portfolio diversification subject to transaction-cost minimization. The model predictions are borne out in the data, supporting the hypothesis that insurers view finance bonds as a diversification tool.
Homeowners Insurance and the Transmission of Monetary Policy (with Christian Kubitza & Jakob Ahm Sørensen) (Link)
We document a novel transmission channel of monetary policy through the homeowners insurance market. On average, contractionary monetary policy shocks result in higher homeowners insurance prices. Using granular data on insurers’ balance sheets, we show that this effect is driven by the interaction of financial frictions and the interest rate sensitivity of investment portfolios. Specifically, rate hikes reduce the market value of insurers’ assets, tightening insurers’ balance sheet constraints and increasing their shadow cost of capital. These frictions in insurance supply amplify the effects of monetary policy on real estate and mortgage markets by making housing less affordable. We find that monetary policy shocks have a stronger impact on home prices and mortgage applications when local insurers are more sensitive to interest rates. This channel is particularly pronounced in areas where households face high climate risk exposure. Our findings highlight the role of insurance markets in amplifying macroeconomic shocks and the interconnections between homeowners insurance, residential real estate, and mortgage lending
The Value of Netting (Link)
Close-out netting is a standard procedure in derivatives markets that protects counterparties' claims on derivatives contracts. Despite the ubiquituous nature in derivatives markets, the literature has not studied counterparties' motivation to use close-out netting. This paper aims to fill this gap. I develop a theoretical model and interpret close-out netting as the option to make a derivative state-dependent. I show that firms use close-out netting as a tool to transfer risk from derivatives counterparties to creditors. Whether the risk-transfer is sub-optimal, however, depends on the type of the derivative. In the case of additional risk sources that make the derivative an imperfect hedge, close-out netting can protect firms' creditors from counterparty risk. The findings of this paper are in line with prior evidence on derivatives contracts and their use in bankruptcy cases.
Wildfires and Financial Markets (with Dries Laurs & Timothy Meyer)
Insurance Companies, Syndicated Loans, and Pecuniary Externalities (with Marcel Brambeer)