THE REINSURANCE DECISION IN LIFE INSURANCE FIRMS: AN EMPIRICAL TEST OF THE RISK-BEARING HYPOTHESIS

Several explanations have been advanced in the financial economics literature to explain the reinsurance decision in insurance firms. Prominent amongst these is the risk-bearing hypothesis which holds that reinsurance is motivated by the ability of residual claimants to effectively hedge against operational risk. Since the efficiency of risk-bearing is influenced by organisational factors, such as ownership structure and firm size, the amount of reinsurance should also vary according to the characteristics of insurance firms. This study tests empirically the hypothesis that reinsurance is related to firm-specific factors. Using 1988–1993 data gathered from New Zealand's life insurance industry, a fixed-effects covariance regression model is estimated. Consistent with expectations, the results indicate that reinsurance is associated with smaller and more highly leveraged life insurance entities, and companies with greater underwriting risk. However, contrary to predictions, it also appears that it is stocks and companies with diversified production that tend to reinsure. The risk-bearing hypothesis thus receives only partial support.     

AN EMPIRICAL TEST OF THE ARBITRAGE PRICING THEORY

This paper provides an ex-post analysis of a multifactor return-generating model using the factor scores obtained from a common factor analysis of industry-based portfolios. For the 1975–1980 time period, the correlations among common stock returns can be adequately explained by a three-factor model. Furthermore, ex post, at least three factors are priced in the stock market. A brief economic interpretation of the proposed common factor is also presented.     

AN EMPIRICAL TEST OF THE TIMING OF BOND-REFUNDING DECISIONS

In this paper we measure the ability of firms to time bond-refunding decisions. The timing performance achieved on a sample of 161 public utility bond refundings is compared with the timing performance achieved by three benchmark models. We find that firms achieve levels of timing performance significantly better than the random selection and 100-basis-point benchmark models, but not significantly better than a stopping-time model based on present value analysis.     

CONVERTIBLE BOND VALUATION: AN EMPIRICAL TEST

This research applies the options pricing model to the valuation of convertible bonds. A numeric algorithm is used to obtain theoretical values for a sample of 103 convertible bond issues. When market prices are compared with model valuations, the means are not significantly different, and 90 percent of model predictions are within 10 percent of market values. As a further test, the sample is divided on the basis of whether the model prices are (1) greater or (2) less than market prices. Returns are compared over a subsequent three-year holding period. The results indicate that without risk adjustment, the returns for the subsample identified by the model as “undervalued” (model prices exceed market prices) are significantly greater than returns for the subsample identified by the model as “overvalued” (market prices exceed model prices).