Reinsurance Demand and Liquidity Creation: A Search for Bi-Causality

63 Pages Posted: 13 Jul 2020

See all articles by Denise Desjardins

Denise Desjardins

University of Montreal - Center for Research on Transportation

Georges Dionne

HEC Montreal - Department of Finance

N'Golo Koné

Queen's University - Department of Economics

Date Written: June 19, 2020

Abstract

We analyze the relationship between insurers’ liquidity creation and reinsurance demand. Early theoretical contributions on liquidity creation propose that financial institutions enhance economic growth by creating liquidity in the economy. Liquidity creation means financing relatively illiquid assets with relatively liquid liabilities. However, liquidity creation exposes insurers to financial risks. There is a trade-off between getting higher returns on risky investments and being able to compensate clients at a low cost when unexpected claims happen. Unexpected claims can be protected by reinsurance, which introduces a second trade-off between reinsurance demand and liquidity creation. This trade-off can be more important for insurers that have fewer diversification opportunities. Our main empirical results, from regularized GMM and ML-SME methods of estimation, show similar positive bi-causal effects between liquidity creation and reinsurance demand for small insurers (22% of insurance activity). The link between the two activities is not significant for large insurers (60% of insurance activity). We obtain mixed results for medium insurers. In all estimations, the standard GMM model is rejected.

Keywords: Reinsurance Demand, Liquidity Creation, Causality, Bi-Causality, Generalized Method of Moments, Maximum Likelihood, Structural Equation Modeling

JEL Classification: C13, C18, C33, C58, G21, G22

Suggested Citation

Desjardins, Denise and Dionne, Georges and Koné, N'Golo, Reinsurance Demand and Liquidity Creation: A Search for Bi-Causality (June 19, 2020). Available at SSRN: https://ssrn.com/abstract=3631054 or http://dx.doi.org/10.2139/ssrn.3631054

Denise Desjardins

University of Montreal - Center for Research on Transportation ( email )

C.P. 6128, Succ. Centre-Ville
Montreal, Quebec H3C 3J7
Canada

Georges Dionne (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-6596 (Phone)
514-340-5019 (Fax)

HOME PAGE: http://www.hec.ca/gestiondesrisques/

N'Golo Koné

Queen's University - Department of Economics ( email )

94 University Avenue
Kingston, Ontario K7L 3N6
Canada
514 652-1005 (Phone)

HOME PAGE: http://www.ngolokone.com

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