The Role of Financial Conditions in Portfolio Choices: The Case of Insurers
Charles A. Dice Working Paper No. 2019-06
59 Pages Posted: 14 Mar 2019 Last revised: 23 Feb 2020
Date Written: February 21, 2020
Many institutional investors depend on the returns they generate to fund their operations and liabilities. How do these investors’ financial conditions affect the management of their portfolios? We address this issue using the insurance industry because insurers are large investors for which detailed portfolio data are available, and can face financial shocks from exogenous weather events that can help us establish causality. Results suggest that more constrained insurers have smaller portfolio weights on riskier and illiquid assets, and have lower realized returns. Among corporate bonds, for which we can control for regulatory treatment, results suggest that more constrained insurers have smaller portfolio weights on riskier corporate bonds. Following operating losses, Property & Casualty (P&C) insurers decrease allocations to riskier corporate bonds. The effect of losses on allocations is likely to be causal since it holds when instrumenting for P&C losses with weather shocks. The change in allocations following losses is larger for more constrained insurers and during the financial crisis, suggesting that the shift toward safer securities is driven by concerns about financial flexibility. The results highlight the importance of financial flexibility to fund operations in institutional investors’ portfolio decisions.
Keywords: Financial conditions, investment, insurer, financial portfolio, asset allocation, risk, liquidity, corporate bonds
JEL Classification: G11, G22, G23, G31, G32
Suggested Citation: Suggested Citation