{"title":"Pure risk, agency conflict, and hedging","authors":"Lu Chen , Bingqing Li , Wenyuan Zheng","doi":"10.1016/j.jbankfin.2024.107294","DOIUrl":null,"url":null,"abstract":"<div><p>This study develops a theoretical model to analyze the asset substitution problem over insurance decisions. We find that agency conflict is related to a firm’s risk level and capital structure. In particular, at the optimal leverage, agency conflict occurs only when the risk level is relatively high, which explains why insurance covenants are typically for significant pure risks. Moreover, when the risk level is specified, agency conflict over insurance decisions occurs within a specific leverage range. This is consistent with the findings of some research on the asset substitution problem over speculative risk choices. In addition, we consider premium loadings and conclude that full hedging is not a firm’s optimal risk management strategy, contributing to the literature on optimal hedging decisions with transaction frictions. Our framework with premium loadings can also explain many insurance phenomena, such as risk retention for small losses and subsidies for catastrophe insurance.</p></div>","PeriodicalId":48460,"journal":{"name":"Journal of Banking & Finance","volume":"168 ","pages":"Article 107294"},"PeriodicalIF":3.6000,"publicationDate":"2024-08-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":"0","resultStr":null,"platform":"Semanticscholar","paperid":null,"PeriodicalName":"Journal of Banking & Finance","FirstCategoryId":"96","ListUrlMain":"https://www.sciencedirect.com/science/article/pii/S0378426624002085","RegionNum":2,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":null,"EPubDate":"","PubModel":"","JCR":"Q1","JCRName":"BUSINESS, FINANCE","Score":null,"Total":0}
引用次数: 0
Abstract
This study develops a theoretical model to analyze the asset substitution problem over insurance decisions. We find that agency conflict is related to a firm’s risk level and capital structure. In particular, at the optimal leverage, agency conflict occurs only when the risk level is relatively high, which explains why insurance covenants are typically for significant pure risks. Moreover, when the risk level is specified, agency conflict over insurance decisions occurs within a specific leverage range. This is consistent with the findings of some research on the asset substitution problem over speculative risk choices. In addition, we consider premium loadings and conclude that full hedging is not a firm’s optimal risk management strategy, contributing to the literature on optimal hedging decisions with transaction frictions. Our framework with premium loadings can also explain many insurance phenomena, such as risk retention for small losses and subsidies for catastrophe insurance.
期刊介绍：
The Journal of Banking and Finance (JBF) publishes theoretical and empirical research papers spanning all the major research fields in finance and banking. The aim of the Journal of Banking and Finance is to provide an outlet for the increasing flow of scholarly research concerning financial institutions and the money and capital markets within which they function. The Journal''s emphasis is on theoretical developments and their implementation, empirical, applied, and policy-oriented research in banking and other domestic and international financial institutions and markets. The Journal''s purpose is to improve communications between, and within, the academic and other research communities and policymakers and operational decision makers at financial institutions - private and public, national and international, and their regulators. The Journal is one of the largest Finance journals, with approximately 1500 new submissions per year, mainly in the following areas: Asset Management; Asset Pricing; Banking (Efficiency, Regulation, Risk Management, Solvency); Behavioural Finance; Capital Structure; Corporate Finance; Corporate Governance; Derivative Pricing and Hedging; Distribution Forecasting with Financial Applications; Entrepreneurial Finance; Empirical Finance; Financial Economics; Financial Markets (Alternative, Bonds, Currency, Commodity, Derivatives, Equity, Energy, Real Estate); FinTech; Fund Management; General Equilibrium Models; High-Frequency Trading; Intermediation; International Finance; Hedge Funds; Investments; Liquidity; Market Efficiency; Market Microstructure; Mergers and Acquisitions; Networks; Performance Analysis; Political Risk; Portfolio Optimization; Regulation of Financial Markets and Institutions; Risk Management and Analysis; Systemic Risk; Term Structure Models; Venture Capital.
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