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A stochastic forward-looking model to assess the profitability and solvency of European insurers
(2016)
In this paper, we develop an analytical framework for conducting forward-looking assessments of profitability and solvency of the main euro area insurance sectors. We model the balance sheet of an insurance company encompassing both life and non-life business and we calibrate it using country level data to make it representative of the major euro area insurance markets. Then, we project this representative balance sheet forward under stochastic capital markets, stochastic mortality developments and stochastic claims. The model highlights the potential threats to insurers solvency and profitability stemming from a sustained period of low interest rates particularly in those markets which are largely exposed to reinvestment risks due to the relatively high guarantees and generous profit participation schemes. The model also proves how the resilience of insurers to adverse financial developments heavily depends on the diversification of their business mix. Finally, the model identifies potential negative spillovers between life and non-life business thorugh the redistribution of capital within groups.
Households buy life insurance as part of their liquidity management. The option to surrender such a policy can serve as a buffer when a household faces a liquidity need. In this study, we investigate empirically which individual and household specific sociodemographic factors influence the surrender behavior of life insurance policyholders. Based on the Socio-Economic Panel (SOEP), an ongoing wide-ranging representative longitudinal study of around 11,000 private households in Germany, we construct a proxy to identify life insurance surrender in the data. We use this proxy to conduct fixed effect regressions and support the results with survival analyses. We find that life events that possibly impose a liquidity shock to the household, such as birth of a child and divorce increase the likelihood to surrender an existing life insurance policy for an average household in the panel. The acquisition of a dwelling and unemployment are further aspects that can foster life insurance surrender. Our results are robust with respect to different models and hold conditioning on region specific trends; they vary however for different age groups. Our analyses contribute to the existing literature supporting the emergency fund hypothesis. The findings obtained in this study can help life insurers and regulators to detect and understand industry specific challenges of the demographic change.
In this paper I assess the effect of interest rate risk and longevity risk on the solvency position of a life insurer selling policies with minimum guaranteed rate of return, profit participation and annuitization option at maturity. The life insurer is assumed to be based in Germany and therefore subject to German regulation as well as to Solvency II regulation. The model features an existing back book of policies and an existing asset allocation calibrated on observed data, which are then projected forward under stochastic financial markets and stochastic mortality developments. Different scenarios are proposed, with particular focus on a prolonged period of low interest rates and strong reduction in mortality rates. Results suggest that interest rate risk is by far the greatest threat for life insurers, whereas longevity risk can be more easily mitigated and thereby is less detrimental. Introducing a dynamic demand for new policies, i.e. assuming that lower offered guarantees are less attractive to savers, show that a decreasing demand may even be beneficial for the insurer in a protracted period of low interest rates. Introducing stochastic annuitization rates, i.e. allowing for deviations from the expected annuitization rate, the solvency position of the life insurer worsen substantially. Also profitability strongly declines over time, casting doubts on the sustainability of traditional life business going forward with the low interest rate environment. In general, in the proposed framework it is possible to study the evolution over time of an existing book of policies when underlying financial market conditions and mortality developments drastically change. This feature could be of particular interest for regulatory and supervisory authorities within their financial stability mandate, who could better evaluate micro- and macro-prudential policy interventions in light of the persistent low interest rate environment.
The modern tontine: an innovative instrument for longevity risk management in an aging society
(2016)
The changing social, financial and regulatory frameworks, such as an increasingly aging society, the current low interest rate environment, as well as the implementation of Solvency II, lead to the search for new product forms for private pension provision. In order to address the various issues, these product forms should reduce or avoid investment guarantees and risks stemming from longevity, still provide reliable insurance benefits and simultaneously take account of the increasing financial resources required for very high ages. In this context, we examine whether a historical concept of insurance, the tontine, entails enough innovative potential to extend and improve the prevailing privately funded pension solutions in a modern way. The tontine basically generates an age-increasing cash flow, which can help to match the increasing financing needs at old ages. However, the tontine generates volatile cash flows, so that - especially in the context of an aging society - the insurance character of the tontine cannot be guaranteed in every situation. We show that partial tontinization of retirement wealth can serve as a reliable supplement to existing pension products.
Common systemic risk measures focus on the instantaneous occurrence of triggering and systemic events. However, systemic events may also occur with a time-lag to the triggering event. To study this contagion period and the resulting persistence of institutions' systemic risk we develop and employ the Conditional Shortfall Probability (CoSP), which is the likelihood that a systemic market event occurs with a specific time-lag to the triggering event. Based on CoSP we propose two aggregate systemic risk measures, namely the Aggregate Excess CoSP and the CoSP-weighted time-lag, that reflect the systemic risk aggregated over time and average time-lag of an institution's triggering event, respectively. Our empirical results show that 15% of the financial companies in our sample are significantly systemically important with respect to the financial sector, while 27% of the financial companies are significantly systemically important with respect to the American non-financial sector. Still, the aggregate systemic risk of systemically important institutions is larger with respect to the financial market than with respect to non-financial markets. Moreover, the aggregate systemic risk of insurance companies is similar to the systemic risk of banks, while insurers are also exposed to the largest aggregate systemic risk among the financial sector.
Life insurers use accounting and actuarial techniques to smooth reporting of firm assets and liabilities, seeking to transfer surpluses in good years to cover benefit payouts in bad years. Yet these techniques have been criticized as they make it difficult to assess insurers’ true financial status. We develop stylized and realistically-calibrated models of a participating life annuity, an insurance product that pays retirees guaranteed lifelong benefits along with variable non-guaranteed surplus. Our goal is to illustrate how accounting and actuarial techniques for this type of financial contract shape policyholder wellbeing, along with insurer profitability and stability. Smoothing adds value to both the annuitant and the insurer, so curtailing smoothing could undermine the market for long-term retirement payout products.
Privacy and its protection is an important part of the culture in the USA and Europe. Literature in this field lacks empirical data from Japan. Thus, it is difficult– especially for foreign researchers – to understand the situation in Japan. To get a deeper understanding we examined the perception of a topic that is closely related to privacy: the perceived benefits of sharing data and the willingness to share in respect to the benefits for oneself, others and companies. We found a significant impact of the gender to each of the six analysed constructs.
Editorial : economic competence and financial literacy of young adults – status and challenges
(2016)
In modern society, the ability to deal with financial and economic matters is becoming increasingly important. This is true for both professionals – e.g., in the investment and banking sectors – and for individuals responsible for managing their financial and economic affairs in everyday life (Aprea et al., in press). This ability is generally described as economic competence, economic literacy or financial literacy. Despite the importance of these constructs, there is still a lack of clarity regarding the exact definitions, and specifically, which components they cover in detail. Furthermore, the terms economic competence and financial literacy are only loosely coupled. Economic competence is usually considered to be more comprehensive than financial literacy. However, recent research on financial literacy has followed a broader approach as well. ...
The necessity for well-founded teacher education in economics – findings from curriculum analyses
(2016)
Everybody has to make daily decisions requiring a good understanding of political and economic systems to manage and design our life but also to react on changes in these systems. Already in the early stages of adulthood, individuals need to decide on which job to choose, which party to vote for or on what money to spend on. For all these activities economical knowledge is necessary, which usually derives from economic education taught in schools in several subjects. ...
The authors take a detailed look at the economic competence and financial literacy of young adults, especially of those who start an apprenticeship or who take up their studies at an university. Economic competence and financial literacy are of special interest within this group, because these young people are – mostly for the first time in their lives – responsible for autonomously managing their own financial affairs and deal with economic challenges.
This paper presents a comprehensive extension of pricing two-dimensional derivatives depending on two barrier constraints. We assume randomness on the covariance matrix as a way of generalizing. We analyse common barrier derivatives, enabling us to study parameter uncertainty and the risk related to the estimation procedure (estimation risk). In particular, we use the distribution of empirical parameters from IBM and EURO STOXX50. The evidence suggests that estimation risk should not be neglected in the context of multidimensional barrier derivatives, as it could cause price differences of up to 70%.
We consider a class of panel tests of the null hypothesis of no cointegration and cointegration. All tests under investigation rely on single-equations estimated by least squares, and they may be residual-based or not. We focus on test statistics computed from regressions with intercept only (i.e., without detrending) and with at least one of the regressors (integrated of order 1) being dominated by a linear time trend. In such a setting, often encountered in practice, the limiting distributions and critical values provided for and applied with the situation “with intercept only” are not correct. It is demonstrated that their usage results in size distortions growing with the panel size N. Moreover, we show which are the appropriate distributions, and how correct critical values can be obtained from the literature.
We use the Italian Survey of Household Income and Wealth, a rather unique dataset with a long time dimension of panel information on consumption, income and wealth, to structurally estimate a buffer-stock saving model. We exploit the information contained in the joint dynamics of income, consumption and wealth to quantify the degree of insurance against income risk. The estimated model implies that Italian households can insure between 89 and 95 percent of a transitory and between 7 and 9 percent of a permanent income shock. Compared to existing empirical estimates for the same dataset, our findings suggest that Italian households do not have access to significant insurance beyond self-insurance.
We designed and fielded an experimental module in the 2014 HRS which seeks to measure older persons’ willingness to voluntarily defer claiming of Social Security benefits. In addition we evaluate the stated willingness of older individuals to work longer, depending on the Social Security incentives offered to delay claiming their benefits. Our project extends previous work by analyzing the results from our HRS module and comparing findings from other data sources, which included very much smaller samples of older persons. We show that half of the respondents would delay claiming if no work requirement were in place under the status quo, and only slightly fewer, 46 percent, with a work requirement. We also asked respondents how large a lump sum they would need with or without a work requirement. In the former case, the average amount needed to induce delayed claiming was about $60,400, while when part-time work was required, the average was $66,700. This implies a low utility value of leisure foregone of only $6,300, or about 10 percent of older households’ income.
We study platform design in online markets in which buying involves a (non-monetary) cost for consumers caused by privacy and security concerns. Firms decide whether to require registration at their website before consumers learn relevant product information. We derive conditions under which a monopoly seller benefits from ex ante registration requirements and demonstrate that the profitability of registration requirements is increased when taking into account the prospect of future purchases or an informational value of consumer registration to the
rm. Moreover, we consider the effectiveness of discounts (store credit) as a means to influence the consumers-registration decision. Finally, we con
rm the profitability of ex ante registration requirements in the presence of price competition.
In the wake of the recent financial crisis, significant regulatory actions have been taken aimed at limiting risks emanating from banks’ trading activities. The goal of this paper is to look at the alternative reforms in the US, the UK and the EU, specifically with respect to the role of proprietary trading. Our conclusions can be summarized as follows: First, the focus on a prohibition of proprietary trading, as reflected in the Volcker Rule in the US and in the current proposal of the European Commission (Barnier proposal), is inadequate. It does not necessarily reduce risk-taking and it is likely to crowd out desired trading activities, thereby possibly affecting financial stability negatively. Second, trading separation into legally distinct or ring-fenced entities within the existing banking organizations, as suggested under the Vickers Report for the UK and the Liikanen proposal for the EU, is a more effective solution. Separation limits cross-subsidies between banking and proprietary trading and diminishes contagion risk, while still allowing for synergies and risk management across banking, non-proprietary trading and proprietary trading.
We provide an assessment of the Basel Committee on Banking Supervision (BCBS) proposal to restrict the internal ratings-based approach on bank risk and to introduce risk-weighted asset floors. If well enforced, risk-sensitive capital regulation results in a more efficient credit allocation compared to the standard approach. Thus, the internal ratings-based approach should be maintained. Further, the use of internal ratings-based output floors potentially results in unintended negative side effects. Input floors are likely a valuable tool to achieve risk-weighted assets comparability. Finally, the proposed measures have a potential detrimental impact for European banks as compared to others.
This paper investigates whether the overpricing of out-of-the money single stock calls can be explained by Tversky and Kahneman’s (1992) cumulative prospect theory (CPT). We argue that these options are overpriced because investors overweight small probability events and overpay for such positively skewed securities, i.e., characteristics of lottery tickets. We match a set of subjective density functions derived from risk-neutral densities, including CPT with the empirical probability distribution of U.S. equity returns. We find that overweighting of small probabilities embedded in CPT explains on average the richness of out-of-the money single stock calls better than other utility functions. The degree that agents overweight small probability events is, however, strongly timevarying and has a horizon effect, which implies that it is less pronounced in options of longer maturity. We also find that time-variation in overweighting of small probabilities is strongly explained by market sentiment, as in Baker and Wurgler (2006).
I show that disruptions to personal sources of financing, aside from commercial lending supply shocks, impair the survival and growth of small businesses. Entrepreneurs holding deposit accounts at retail banking institutions that defaulted following the financial crisis reduce personal borrowing and are consequently more likely to exit their firm. Exposure to the corresponding investment losses from delisted publicly traded bank stocks strongly reduces the rate of firm survival, particularly for early-stage ventures. At the intensive margin, owners who remain in business reduce employees after personal wealth losses. My results suggest that personal finance is an important component of firm financing.
We develop a model that endogenizes the manager's choice of firm risk and of inside debt investment strategy. Our model delivers two predictions. First, managers have an incentive to reduce the correlation between inside debt and company stock in bad times. Second, managers that reduce such a correlation take on more risk in bad times. Using a sample of U.S. public firms, we provide evidence consistent with the model's predictions. Our results suggest that the weaker link between inside debt and company stock in bad times does not translate into a mitigation of debt-equity conflicts.