Asymmetric Information and Insurance Cycles
35 Pages Posted: 22 Mar 2009 Last revised: 26 Jul 2021
Date Written: July 24, 2021
This paper extends the theoretical literature on underwriting cycles by assuming insurers have heterogeneous exposure to a given catastrophe. Distinct from the existing literature on insurance cycles, we model optimal contracting by competitive insurers. Since losses take time to pay out, and insurers are better informed about their catastrophe exposure than outside investors, catastrophes compromise the capital-raising ability of insurers by increasing asymmetric information. Capital is restricted following a catastrophe because investors do not know the catastrophe exposure of each insurer, not because of explicit costs of raising capital. Thus, insurers decide to hold less capital following a catastrophe, giving rise to the insurance cycle.
Keywords: Asymmetric Information, Catastrophe, Insurance Underwriting Cycle, Liquidity Crisis
JEL Classification: D41, D82, G01, G22, G28, G32
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