Estimating the Cost of Equity Capital for Insurance Firms with Multi-Period Asset Pricing Models
Journal of Risk and Insurance, Forthcoming
38 Pages Posted: 14 Aug 2018
Date Written: July 28, 2018
Previous research on insurer cost of equity (COE) focuses on single-period asset pricing models. In reality, however, investment and consumption decisions are made over multiple periods, exposing firms to time-varying risks related to economic cycles and market volatility. We extend the literature by examining two multi-period models—the conditional CAPM (CCAPM) and the intertemporal CAPM (ICAPM). Using 29 years of data, we find that macroeconomic factors significantly influence and explain insurer stock returns. Insurers have counter-cyclical beta implying that their market risk increases during recessions. Further, insurers are sensitive to volatility risk (the risk of losses when volatility goes up), but not to insurance-specific risks, financial industry risks, liquidity risk, or co-skewness after controlling for other economy-wide factors.
Keywords: Cost of Equity, Multi-period Asset Pricing Models, Time-varying Risks, Volatility Risk, ICAPM, Conditional CAPM
JEL Classification: G12, G22, G31
Suggested Citation: Suggested Citation