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Do Asset Regulations Impede Portfolio Diversification? Evidence from European Life Insurance Funds

25 Pages Posted: 24 Jul 2012 Last revised: 5 Feb 2013

Mohan Bijapur

London School of Economics

Manuela Croci

National Bank of Abu Dhabi

Rida Zaidi

The Royal Bank of Scotland

Date Written: July 19, 2012

Abstract

We investigate the effects of regulatory restrictions on the amounts invested in risky asset classes in life insurance funds across EU countries. By estimating a panel data econometric model, we find that these restrictions have an economically and statistically significant negative impact on risk-adjusted returns of approximately 1-2 percentage points, holding constant other relevant factors. The use of explicit limits on asset allocation can be a blunt instrument for regulating risk-taking, in that they impede investment managers’ ability to exploit the benefits of portfolio diversification, and thus distort portfolio selection below the efficient frontier. We also find that those countries which impose the most stringent constraints tend to experience the largest efficiency losses. Furthermore, our results suggest that firms subject to prescriptive regulation are less able to respond quickly under conditions of financial market turbulence. Our results are robust to inclusion of additional controls, tests for fixed effects and country-specific heterogeneity, and other robustness checks.

Keywords: financial regulation, asset allocation, portfolio risk diversification, life insurance funds

JEL Classification: G11, G22, G28

Suggested Citation

Bijapur, Mohan and Croci, Manuela and Zaidi, Rida, Do Asset Regulations Impede Portfolio Diversification? Evidence from European Life Insurance Funds (July 19, 2012). Available at SSRN: https://ssrn.com/abstract=2116715 or http://dx.doi.org/10.2139/ssrn.2116715

Mohan Bijapur (Contact Author)

London School of Economics ( email )

United Kingdom

HOME PAGE: http://personal.lse.ac.uk/bijapurm/

Manuela Croci

National Bank of Abu Dhabi ( email )

PO Box 59212
AL Ain
United Arab Emirates

Rida Zaidi

The Royal Bank of Scotland ( email )

36 St Andrew Square
Edinburgh, EH2 2YB
United Kingdom

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