New Developments in Long-Term Asset Management
Monika Piazzesi and Luis Viceira, Organizers
Second Annual Conference
New York, New York
May 19-20, 2017
Financial Intermediaries as Asset Insulators during Crises
Financial institutions hold tens of trillions of dollars of financial securities. Ganbriel Chodorow-Reich of Harvard University, Andra C. Ghent of the University of Wisconsin, and Valentin Haddad of Princeton University investigate whether this organization of ownership matters. Specifically, they ask, during periods when securities trade at deep discounts, as in the 2008 financial crisis, do intermediaries amplify price drops or do they shield their investors from these temporary fluctuations? [Download the paper]
Other Conference Papers
Institutional Investors and Information Acquisition, Matthijs Breugem and Adrian Buss
The researchers suggest that some financial intermediaries act as asset insulators, holding assets for the long run, protecting asset valuations from exposure to financial markets, and thus formalizing why some institutions can create value by behaving as "buy and hold" investors. This proposition generates predictions for the behavior of asset insulators' market equity, portfolio choice, liability structure, and trading behavior. The researchers illustrate the empirical relevance of this theory in the context of a large class of intermediaries, the life insurance sector.
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The balance sheets of life insurers exemplify an asset-insulation strategy. Insulators should target assets which have a large wedge between their valuation on and off the market. Illiquid, risky assets provide such an opportunity. The largest concentration of insurers' holdings is in risky corporate bonds, while highly liquid Treasuries and agency bonds constitute only about 13 percent of their assets. This pattern is at odds with the common view of insurers making portfolio choices primarily to offset the interest rate risk of their policy liabilities. Insurance companies also trade infrequently and finance their balance sheets by issuing stable long-term liabilities in the form of insurance policies and annuities.
Viewing insurers as asset insulators helps to resolve otherwise puzzling low frequency changes in the equity value of the life insurance sector during the 2008-09 financial crisis. During 2008, because of the sharp drop in interest rates, the value of policy liabilities of publicly traded insurers increased by more than $96 billion. At the same time, the risky assets held by these insurers lost at least $30 billion. Without insulation, there would have been a loss of more than $126 billion in the value of the equity. In practice, insurers' equity dropped by "only" $80 billion. Insulation provides an interpretation for this outcome: during the crisis, fire sale discounts and increased illiquidity caused market prices of assets to temporarily decline, resulting in an increase in the comparative advantage of holding assets inside an insulator and raising their franchise value.