The Illiquidity Discount of Life Insurance Investments
Zeitschrift für die gesamte Versicherungswissenschaft, Vol. 105, Issue 3, 2016
Posted: 7 Mar 2016 Last revised: 7 Nov 2016
Date Written: September 16, 2016
Abstract
We incorporate an illiquid life insurance investment in the multi-period investment strategy of an investor with constant relative risk aversion and independent and identically distributed returns. In our setup, the liquid and the illiquid assets are risky and correlated and the illiquid investment cannot be rebalanced. We calculate the illiquidity discount as the difference in certainty equivalent rates of return between the optimal strategy with all assets being rebalanced in each period and the strategy with the illiquid investment. Calibrating our model to data of the German market we find a negative relationship between the level of risk aversion and the illiquidity discount when the investor does not rebalance at all. However, when the investor rebalances his liquid assets in each period to hedge against the illiquid investment the illiquidity discount becomes economically negligible.
Keywords: illiquidity, life insurance, CRRA, portfolio optimization
JEL Classification: D14, G11
Suggested Citation: Suggested Citation