Estimating the Cost of Equity Capital for Insurance Firms With Multiperiod Asset Pricing Models

Previous research on insurer cost of equity (COE) focuses on single-period asset pricing models. In reality, however, investment and consumption decisions are made over multiple periods, exposing firms to time-varying risks related to economic cycles and market volatility. We extend the literature b...

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Bibliographic Details
Published inThe Journal of risk and insurance Vol. 87; no. 1; pp. 213 - 245
Main Authors Barinov, Alexander, Xu, Jianren, Pottier, Steven W.
Format Journal Article
LanguageEnglish
Published Malvern Wiley Periodicals, Inc 01.03.2020
John Wiley & Sons, Inc
Blackwell Publishing Ltd
Subjects
Analysis
Capital assets
CAPM
Cost of capital
Economic aspects
Economic models
Equity capital
Insurance industry
Market risk
Prices and rates
Pricing
Pricing policies
Volatility
United States
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Summary:Previous research on insurer cost of equity (COE) focuses on single-period asset pricing models. In reality, however, investment and consumption decisions are made over multiple periods, exposing firms to time-varying risks related to economic cycles and market volatility. We extend the literature by examining two multiperiod models—the conditional capital asset pricing model (CCAPM) and the intertemporal CAPM (ICAPM). Using 29 years of data, we find that macroeconomic factors significantly influence and explain insurer stock returns. Insurers have countercyclical beta, implying that their market risk increases during recessions. Further, insurers are sensitive to volatility risk (the risk of losses when volatility goes up), but not to insurance-specific risks, financial industry risks, liquidity risk, or coskewness after controlling for other economy-wide factors.
ISSN:0022-4367
1539-6975
DOI:10.1111/jori.12267