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On the pricing of intermediated risks : theory and application to catastrophe reinsurance

Author: Kenneth Froot; Paul G J O'Connell; National Bureau of Economic Research.
Publisher: Cambridge, MA : National Bureau of Economic Research, ©1997.
Series: Working paper series (National Bureau of Economic Research), working paper no. 6011.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
Abstract: We model the equilibrium price and quantity of risk transfer between firms and financial intermediaries. Value-maximizing firms have downward sloping demands to cede risk, while intermediaries, who assume risk, provide less-than-fully-elastic supply. We show that equilibrium required returns will be high' in the presence of financing imperfections that make intermediary capital costly. Moreover, financing  Read more...
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Additional Physical Format: Print version:
Froot, Kenneth.
On the pricing of intermediated risks.
Cambridge, MA : National Bureau of Economic Research, ©1997
(OCoLC)36945307
Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Kenneth Froot; Paul G J O'Connell; National Bureau of Economic Research.
OCLC Number: 647512261
Reproduction Notes: Electronic reproduction. [S.l.] : HathiTrust Digital Library, 2010. MiAaHDL
Description: 1 online resource (36 pages) : illustrations.
Details: Master and use copy. Digital master created according to Benchmark for Faithful Digital Reproductions of Monographs and Serials, Version 1. Digital Library Federation, December 2002.
Series Title: Working paper series (National Bureau of Economic Research), working paper no. 6011.
Responsibility: Kenneth A. Froot, Paul G.J. O'Connell.

Abstract:

Abstract: We model the equilibrium price and quantity of risk transfer between firms and financial intermediaries. Value-maximizing firms have downward sloping demands to cede risk, while intermediaries, who assume risk, provide less-than-fully-elastic supply. We show that equilibrium required returns will be high' in the presence of financing imperfections that make intermediary capital costly. Moreover, financing imperfections can give rise to intermediary market power, so that small changes in financial imperfections can give rise to large changes in price. We develop tests of this alternative against the null that the supply of intermediary capital is perfectly elastic. We take the US catastrophe reinsurance market as an example, using detailed data from Guy Carpenter & Co., covering a large fraction of the catastrophe risks exchanged during 1970-94. Our results suggest that the price of reinsurance generally exceeds fair' values, particularly in the aftermath of large events, that market power of reinsurers is not a complete explanation for such pricing, and that reinsurers' high costs of capital appear to play an important role.

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