This paper examines how credit guarantees and government subsidies impact investment in a regime-switching model. We provide new explicit pricing formulas for a general standard asset. Almost all common corporate securities’ prices can be easily derived by the explicit formulas though project cash flows are driven by both a Brownian motion and a two-state Markov chain. We provide a method about how governments should specify a proper tax subsidy standard for a given tax rate to motivate a firm to invest in a project in the way they wish. If the tax subsidy is sufficiently high (low), an overinvestment (underinvestment) occurs. The higher the tax rate, the more significant the overinvestment (underinvestment). We pin down the subsidy amount required for motivating a firm to invest immediately and fix the optimal capital structure with government subsidies.

Reinsurers may default when they have to pay large claims to insurers but are unable to fulfill their obligations due to various reasons such as catastrophic events, underwriting losses, inadequate capitalization, or financial mismanagement. This paper studies the problem of optimal reinsurance design from the perspectives of both the insurer and reinsurer when the insurer faces the potential default risk of the reinsurer. If the insurer aims to minimize the convex distortion risk measure of his retained loss, we prove the optimality of a stop-loss treaty when the promised ceded loss function is charged by the expected value premium principle and the reinsurer offers partial recovery in the event of default. For any fixed premium loading set by the reinsurer, we then derive the explicit expressions of optimal deductible levels for three special distortion functions, including the TVaR, Gini, and PH transform distortion functions. Under these three explicit distortion risk measures adopted by the insurer, we seek the optimal safety loading for the reinsurer by maximizing her net profit where the reserve capital is determined by the TVaR measure and the cost is governed by the expectation. This procedure ultimately leads to the Bowley solution between the insurer and the reinsurer. We provide several numerical examples to illustrate the theoretical findings. Sensitivity analyses demonstrate how different settings of default probability, recovery rate, and safety loading affect the optimal deductible values. Simulation studies are also implemented to analyze the effects induced by the default probability and recovery rate on the Bowley solution.

In this paper, we explore how to design the optimal insurance contracts when the insured faces insurable, counterparty, and additive background risk simultaneously. The target is to minimize the mean-variance of the insured’s loss. By utilizing the calculus of variations, an implicit characterization of the optimal ceded loss function is given. An explicit structure of the optimal ceded loss function is also provided by making full use of its implicit characterization. We further derive a much simpler solution when these three kinds of risk have some special dependence structures. Finally, we give a numerical example to illustrate our results.

This article questions the drivers behind the distribution of savings in different capital markets in Portugal between 1550 and 1800. A novel dataset of credit transactions, interest rates and debt service documents a shift in the lenders' investment behaviour. By 1712, one of the leading institutional creditors—the Misericórdias—had ceased to allocate funds to the sovereign debt market. Data reveal that this disinvestment was neither related to the poor performance of debt service nor to the lure of potentially higher returns on private credit. We argue that changes in the rationales for issuing debt justify the drop in the number of institutional investors in the public credit market, and this correlates with the heavy allocation of funds into private lending.

Although potentially useful for financially hedging systemic weather-related risks, weather contracts/derivatives (also referred to as parametric insurance) have not seen wide adoption in agriculture outside of applications in developing countries, frequently supported by governments and non-governmental organizations (NGOs). A significant impediment is the lack of financial firms willing to stand ready to sell weather derivatives to individual agricultural producers in the over-the-counter market who, due to the localized nature of weather, face idiosyncratic weather-related risks. In particular, the administrative and reinsurance costs of supplying relatively small contracts with specific terms to many different producers are often prohibitive. The current study considers the potential use of weather derivatives in hedging the aggregate yield/revenues of viticulture producers represented by an industry association located in the province of Ontario, Canada. We examine the sensitivity of aggregate industry yields to several relevant weather-related risks employing copula function analysis. We then consider the potential of a weather derivative in hedging the financial risk associated with cold winter temperatures, which pose the greatest risk to aggregate vinifera yields. The issue of attributing costs and payouts to individual association members remains unresolved, and several alternatives are suggested.

Risk measurements are clearly central to risk management, in particular for banks, (re)insurance companies, and investment funds. The question of the appropriateness of risk measures for evaluating the risk of financial institutions has been heavily debated, especially after the financial crisis of 2008/2009. Another concern for financial institutions is the pro-cyclicality of risk measurements. In this paper, we extend existing work on the pro-cyclicality of the Value-at-Risk to its main competitors, Expected Shortfall, and Expectile: We compare the pro-cyclicality of historical quantile-based risk estimation, taking into account the market state. To characterise the latter, we propose various estimators of the realised volatility. Considering the family of augmented GARCH(p, q) processes (containing well-known GARCH models and iid models, as special cases), we prove that the strength of pro-cyclicality depends on the three factors: the choice of risk measure and its estimators, the realised volatility estimator and the model considered, but, no matter the choices, the pro-cyclicality is always present. We complement this theoretical analysis by performing simulation studies in the iid case and developing a case study on real data.

This article explores the financing of early industrial corporations using newly constructed panel data from Imperial Russian balance sheets. We document how corporate capital structures and dividend payout policies reflected internal agency issues, information asymmetries with external investors, life cycle considerations, and other frictions present in the Russian context. In particular, we find that widely held, listed and more profitable corporations were less reliant on debt financing. Asset tangibility was associated with lower debt levels, suggesting that Russian corporate debt was short-term, collateral was largely irrelevant, or agency problems dominated. Finally, we find that many of these same issues, for example ownership structure and access to securities markets, also mattered for financial performance and that dividends may have compensated investors for poor legal protections.

This article analyses trends in the development of the stock exchange in Jakarta between its stepwise institutionalisation since 1898 and its closure in 1942. The article contributes to literature on the significance of stock markets in the process of mobilising external capital for investment by private enterprise in emerging economies. It finds that the brokers participating in the stock exchange traded shares and bonds of companies operating in Indonesia and registered in Indonesia or in the Netherlands. Many of these securities were also traded on the much larger stock exchange in Amsterdam. Although formally independent, both securities markets were integrated. Based on estimates of relatively high market capitalisation during 1901–40, the article concludes that the Jakarta and Amsterdam stock exchanges together contributed significantly to the mobilisation of private investment and the development of private enterprise in Indonesia.

This paper compares how pension obligations impact the market value of United States corporations under two accounting regimes. Using a sample of firms that disclosed pension liabilities under Statement of Financial Accounting Standards (SFAS) No. 87 from 2001 to 2005 and recognized them under SFAS No. 158 from 2006 to 2014, I find that equity market participants take into account the net position of the pension fund only if it is recognized on the sponsor's balance sheet, thus mispricing the pension deficit/surplus under the disclosure regime. I also provide evidence suggesting that investors' perception of pension deficits/surpluses changed with the introduction of SFAS No. 158 in 2006.

We examine the relationship credit access has had with the U.S. agricultural productivity and residual returns to resources. Our theoretical analysis suggests that limited credit access can be sufficient to prevent a representative farmer from maximizing both short- and long-run profits. Empirical results show that increased credit access is positively associated with both productivity and residual returns to resources. Our findings imply that one way to stimulate the U.S. agricultural productivity growth is to increase credit access. They also provide strong empirical support for the productivity-stimulating value of programs such as the Farm Service Agency’s Farm Loan Program.

This paper studies a problem of optimal reinsurance design under asymmetric information. The insurer adopts distortion risk measures to quantify his/her risk position, and the reinsurer does not know the functional form of this distortion risk measure. The risk-neutral reinsurer maximizes his/her net profit subject to individual rationality and incentive compatibility constraints. The optimal reinsurance menu is succinctly derived under the assumption that one type of insurer has a larger willingness to pay than the other type of insurer for every risk. Some comparative analyses are given as illustrations when the insurer adopts the value at risk or the tail value at risk as preferences.

This paper introduces an integrated asset-liability management model that allows for the joint quantitative analysis of capital structure choices, pension fund allocation decisions and rational pricing of liabilities. We confirm that capital structure decisions have a substantial impact on the value of pension claims, and we provide a quantitative assessment of the mispricing induced by the use of an arbitrary regulatory discount rate. We also present a quantitative assessment of the asset substitution effect implied by a change in the pension fund allocation to risky assets taking place after the corporate and pension obligation claims have been issued.

We test the effect of institutional quality on capital structure in the microfinance setting. In doing this, we rely on data from 532 microfinance institutions (MFIs) located in 73 countries dotted across the six microfinance regions in the world. We observe that institutional quality exhibits a robust negative and statistically significant relationship with capital structure in both the short and long run, implying that MFIs in countries with a better institutional environment are less likely to utilize more debt. Our moderation analysis furnishes us with evidence that the presence of women on the board of an MFI significantly moderates the relationship between institutional quality and its capital structure. We show that in the presence of more female representation on the boards of MFIs, the tendency of MFIs using less debt is higher.

Variable annuity (VA) policies are typically issued on mutual funds invested in both fixed income and equity asset classes. However, due to the lack of specialized models to represent the dynamics of fixed income fund returns, the literature has primarily focused on studying long-term investment guarantees on single-asset equity funds. This article develops a mixed bond and equity fund model in which the fund return is linked to movements of the yield curve. Theoretical motivation for our proposed specification is provided through an analogy with a portfolio of rolling horizon bonds. Moreover, basis risk between the portfolio return and its risk drivers is naturally incorporated into our framework. Numerical results show that the fit of our model to Canadian VA data is adequate. Finally, the valuation of VAs is illustrated and it is found that the prevailing interest rate environment can have a substantial impact on guarantee costs.

In this study, we propose new risk measures from a regulator’s perspective on the regulatory capital requirements. The proposed risk measures possess many desired properties, including monotonicity, translation-invariance, positive homogeneity, subadditivity, nonnegative loading, and stop-loss order preserving. The new risk measures not only generalize the existing, well-known risk measures in the literature, including the Dutch, tail value-at-risk (TVaR), and expectile measures, but also provide new approaches to generate feasible and practical coherent risk measures. As examples of the new risk measures, TVaR-type generalized expectiles are investigated in detail. In particular, we present the dual and Kusuoka representations of the TVaR-type generalized expectiles and discuss their robustness with respect to the Wasserstein distance.

Social discounting conventions vary widely. Some differences reflect institutional constraints, but many reflect differing assumptions about how a social discount rate should be derived and applied. The divide between advocates of social opportunity cost and social time preference (STP) frameworks seems unbridgeable. There is no consensus among STP advocates on whether the social cost of funding $1 of public spending is barely more than $1 of consumption or perhaps more than $2; or on whether the covariance of public service benefits with income merits a discount rate premium that is trivial or a few percentage points. The practicalities of government fund raising are sometimes overlooked. The issues are here reviewed in the light of the literature and of experience with developing and applying social discounting regimes and extended debates within government.

Executive stock options (ESOs) are widely used to reward employees and represent major items of corporate liability. The International Accounting Standards Board IFRS9 financial reporting standard which came into full effect on 1-Jan 2018, along with its Australian implementation AASB9, requires public corporations to report their fair-value cost in financial statements. Reset ESOs are typically issued to re-incentivise employees by allowing the option to be cancelled and re-issued with a lower exercise price or later maturity. We produce a novel analytical Reset ESO valuation consistent with the IFRS9 financial reporting standard incorporating the simultaneous resetting of vesting period, exercise window, reset level and maturity. We allow for voluntary and involuntary exercise. Our analytical result is expressed solely in terms of standardised European binary power option instruments. Using the multi-state mortality model of Hariyanto (2014, Mortality and disability modelling with an application to pricing a reverse mortgage contract, PhD thesis, University of Melbourne), we estimate longitudinal disability and death transition probabilities from cross-sectional data. We determine survival functions for pre-vesting forfeiture or post-vesting involuntary exercise for use with weighted portfolios of our formulae to illustrate the effect of survival on the fair value. We examine the IFRS9 method of valuation using expected time to option exercise and demonstrate a consistent overestimation of fair value of up to 27% for senior executives.

We return to the long-standing question ‘Who owns the assets in a defined benefit pension plan?’ Unlike earlier studies, we condition the market's assessment of implicit property rights on the sponsoring firm's financial health. Valuations of financially strong firms, and those that are strengthening, are more responsive to pension plan funding. For these firms, each extra dollar of net plan assets is valued at between $0.50 and $1.00. In contrast, for weak and weakening firms, valuation effects are statistically indistinguishable from zero. This result is consistent with the higher likelihood that they will renege on their pension obligations.

We link causally the riskiness of men's management of their finances with the probability of their experiencing a divorce. Our point of departure is that when comparing single men to married men, the former manage their finances in a more aggressive (that is, riskier) manner. Assuming that single men believe that low relative wealth has a negative effect on their standing in the marriage market and that they care about their standing in that market more than married men do, we find that a stronger distaste for low relative wealth translates into reduced relative risk aversion and, consequently, into riskier financial behavior. With this relationship in place we show how this difference varies depending on the “background” likelihood of divorce and, hence, on the likelihood of re-entry into the marriage market: married men in environments that are more prone to divorce exhibit risk-taking behavior that is more similar to that of single men than married men in environments that are little prone to divorce. We offer a theoretical contribution that helps inform and interpret empirical observations and regularities and can serve as a guide for follow-up empirical work, having established and identified the direction of causality.

A method to hedge variable annuities in the presence of basis risk is developed. A regime-switching model is considered for the dynamics of market assets. The approach is based on a local optimization of risk and is therefore very tractable and flexible. The local optimization criterion is itself optimized to minimize capital requirements associated with the variable annuity policy, the latter being quantified by the Conditional Value-at-Risk (CVaR) risk metric. In comparison to benchmarks, our method is successful in simultaneously reducing capital requirements and increasing profitability. Indeed the proposed local hedging scheme benefits from a higher exposure to equity risk and from time diversification of risk to earn excess return and facilitate the accumulation of capital. A robust version of the hedging strategies addressing model risk and parameter uncertainty is also provided.