Life Insurer Cost of Equity with Asymmetric Risk Factors

Abstract

Although various asymmetric measures of market risk have been shown to be priced factors for the broader equity market, life insurer realized equity returns include a much larger premium for bearing downside risk, even after controlling for firm characteristics and other measures of risk. Cross-sectional regression analysis finds a positive (negative) premium for downside (upside) betas, conditional on down and up markets respectively. Coskewness and cokurtosis are also priced factors. Given the life insurance industry’s unique role in providing long term protection to U.S. households and the relative importance of market returns to firm performance in this industry, equity investors in these firms require a larger premium for bearing this type of risk than is typical for stocks in other industries.

Keywords: Cost of equity; Upside risk; Downside risk; Equity market; Life insurance industry

JEL Classification: G12, G22