When Gambling for Resurrection is Too Risky

IMF Working Papers, August 1, 2017

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Insurers in the United States that were hit hard by the crisis reduced risk taking relative to insurers not hit as hard by the crisis.
Capital requirements alone do not explain this risk reduction: insurers hit hard reduced risk within assets with identical regulatory treatment.
State level US insurance regulation makes it unlikely this risk reduction was driven by moral suasion.
Applying the same approach to banks yields similar results: other financial institutions also reduce risk after large shocks.
The results suggest that, at least in some circumstances, franchise value can dominate, making gambling for resurrection too risky.

Comparative analysis between insurers "hit hard" by the crisis and insurers "not hit as hard."
Within-asset comparisons to control for identical regulatory treatment.
Extension of the approach to banks, which produces similar risk-reduction findings.

Franchise value considerations can lead financial institutions to reduce risk following large negative shocks rather than engage in risk shifting or “gambling for resurrection.”
Regulatory explanations such as capital requirements do not fully account for observed post-shock risk-reduction behavior among insurers.
State-level regulatory structures in the US reduce the likelihood that moral suasion by regulators was the primary driver of the observed behavior.

Subject: Banking, Bonds, Corporate bonds, Credit risk, Financial institutions, Financial regulation and supervision, Insurance, Insurance companies
Keywords: banking, Bonds, bonds insurer, capital requirement, Corporate bonds, Credit risk, fair value, financial frictions, franchise value, Insurance, Insurance companies, interest-rate risk, issued bond, Life insurance, risk reduction, risk shifting, WP, yield to maturity

Divya Kirti. "When Gambling for Resurrection is Too Risky", IMF Working Papers 2017, 180 (2017).

When Gambling for Resurrection is Too Risky, WP/17/180, August 2017
- When Gambling for Resurrection is Too Risky, WP/17/180, August 2017 (Markdown version)
- When Gambling for Resurrection is Too Risky, WP/17/180, August 2017 (PDF)