Great (and Not So Great) Expectations: An Engogenous Economic Explication of Insurance Cycles and Liability Crises

Abstract
The causes of insurance cycles and liability crises have been vigorously sought, claimed, and debated by academic investigators for years. The model provided here partially synthesizes several stands of this literature and provides an additional cause. In addition to causes such as the loss-shocks and interest-rate changes included as explanations in the literature, this model posits changing expectations about the parameters of corporate net income as causes of cycles and crises. Since both sides of the market form expectations about losses and interest rates, changes in both demand and supply in the market are incorporated in the explanation. Changing expectations during the crisis reduced supply and made it more inelastic. The same changing expectations increased demand and made it more inelastic and so amplified the effect due to a change in supply. The model predicts an increase in the equilibrium premium, when the mean and variance of losses increase. The model also predicts an increase in the equilibrium premium when the mean interest rate decreases and variance increases. The empirical results of cross-sectional regression and time-series analyses are consistent with the predictions. The analysis then provides some insight on how to dampen future cycles and reduce the effect of future liability crises.
Volume
67:4
Page
617-652
Year
2000
Categories
Actuarial Applications and Methodologies
Accounting and Reporting
Annual Statement
Financial and Statistical Methods
Statistical Models and Methods
Regression
Financial and Statistical Methods
Statistical Models and Methods
Time Series
Financial and Statistical Methods
Asset and Econometric Modeling
Actuarial Applications and Methodologies
Dynamic Risk Modeling
Publications
Journal of Risk and Insurance, The
Prizes
American Risk and Insurance Association Prize
Authors
Patrick L Brockett
Hung-Gay Fung
Richard D MacMinn