Interest Rate Risk and Equity Values of Life Insurance Companies: A GARCH-M Model

23 Pages Posted: 24 May 2007  

Elijah Brewer

DePaul University - Department of Finance; Federal Reserve Bank of Chicago

James M. Carson

University of Georgia

Elyas Elyasiani

Temple University - Department of Finance

Iqbal Mansur

Widener University - School of Business Administration

William L. Scott

Illinois State University

Abstract

The importance of managerial decisions related to interest-sensitive cash flows has received considerable attention in the insurance literature. Consistent with the interest-sensitive nature of insurer assets and liabilities, empirical research has shown that insurer insolvency is significantly related to interest rate volatility. We investigate the interest rate sensitivity of monthly stock returns of life insurers based on a generalized autoregressive conditionally heteroskedastic in the mean (GARCH-M) model. We examine three different portfolios (equally weighted, risk-based, and size-based) with binary variables to explicitly account for varying interest rate strategies adopted by the Federal Reserve System. Results based on data for the period 1975 through 2000 indicate that life insurer equity values are sensitive to long-term interest rates and that interest sensitivity varies across subperiods and across risk-based and size-based portfolios. The results complement insolvency research that links insurer financial performance to changes in interest rates.

Suggested Citation

Brewer, Elijah and Carson, James M. and Elyasiani, Elyas and Mansur, Iqbal and Scott, William L., Interest Rate Risk and Equity Values of Life Insurance Companies: A GARCH-M Model. Journal of Risk & Insurance, Vol. 74, No. 2, pp. 401-423, June 2007. Available at SSRN: https://ssrn.com/abstract=987404 or http://dx.doi.org/10.1111/j.1539-6975.2007.00218.x

Elijah Brewer

DePaul University - Department of Finance ( email )

1 East Jackson Blvd.
Chicago, IL 60604-2287
United States

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

James M. Carson (Contact Author)

University of Georgia ( email )

Athens, GA 30602-6254
United States

Elyas Elyasiani

Temple University - Department of Finance ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States
215-204-5881 (Phone)
215-204-5698 (Fax)

Iqbal Mansur

Widener University - School of Business Administration ( email )

3800 Vartan Way
PO Box 69381
Harrisburg, PA 17106-9381
United States

William L. Scott

Illinois State University ( email )

Normal, IL 61761
United States
309-438-8777 (Phone)

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