Hedge the Hedgers: Usage of Reinsurance and Derivatives by Property and Casualty Insurance Companies
37 Pages Posted: 28 May 2008 Last revised: 20 Apr 2014
Date Written: February 29, 2008
This paper studies the usage of two common hedging tools, reinsurance and derivatives, by property and casualty insurance companies. In a simple mean-variance efficient optimization model, the two hedging tools display substitutive effect when asset and liability do not display strong natural hedging. I verify this relationship using a six-year insurance company firm-level data on reinsurance usage and off-balance sheet derivative trading recorded between 2000 and 2005. Controlling for firm specific variables, such as size, return and credit rating, such substitution effect indeed exists in the insurance companies' hedging decisions under a two-stage simultaneous equation framework.
Keywords: Hedging, Derivatives, Insurance, Reinsurance
JEL Classification: G22, D21, G39
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