New Developments in Long-Term Asset Management

Supported by the Norwegian Finance Initiative
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 Relevance of Broker Networks for Information Diffusion in the Stock Market, Marco Di Maggio, Francesco A. Franzoni, Amir Kermani, and Carlo Sommavilla

Do Institutional Incentives Distort Asset Prices? Anton Lines

Chasing Private Information, Marcin T. Kacperczyk and Emiliano Pagnotta

ETF Arbitrage under Liquidity Mismatch, Kevin Pan and Yao Zeng

Replicating Private Equity, Erik Stafford

Efficiently Inefficient Markets for Assets and Asset Management, Nicolae Gârleanu and Lasse Heje Pedersen

< 2016 Conference Papers>
< 2018 Conference Papers>

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.

The researchers' model of asset insulation relies on two key ingredients: First, the value of assets on traded markets is affected by shocks that do not affect value if held for the long run, such as illiquidity, fire sales, and market sentiment. Second, even with stable liabilities, deterioration in asset values threatens the health of the firm and can force the intermediary to liquidate its holdings at prevailing market prices. The risk of liquidation limits the provision of insulation, especially during episodes of market distress.

Download the paper

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.

To further discriminate asset insulation from alternative theories of intermediation, the researchers introduce the asset pass-through ratio, the change in market value of a firm’s equity in response to a dollar change in the market value of the firm's assets. Absent frictions, the pass-through ratio would be one. The asset-insulator model predicts a pass-through ratio typically below one, reflecting insensitivity to market fluctuations, but rising in periods of financial distress as the deterioration in the financial health of the intermediary threatens its ability to act as a long-lived investor. The researchers estimate that a one dollar drop in asset values in any period other than the 2008-09 financial crisis results in a decline in equity of about 10 cents, while during the crisis the pass-through ratio rises to approximately one, uniquely consistent with the insulator view. The pass-through ratio rises more during the crisis for insurers with larger overall declines in their stock price around the Lehman bankruptcy, providing further evidence that poor financial health during this period contributes to lower insulation from market movements.


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.

The researchers conclude by noting that the behavior of insurer equity during this period highlights a core tension in the provision of asset insulation. The crisis coincided with a deterioration in the financial health of insurers, putting them closer to liquidation and threatening their ability to insulate assets from market movements. Thus, asset insulation may be most fragile exactly when it is most valuable.

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