Capped borrower credit risk and insurer hedging during the COVID-19 outbreak

Shi Chen; Yang Yang; Jyh-Horng Lin

doi:10.1016/j.frl.2020.101744

Capped borrower credit risk and insurer hedging during the COVID-19 outbreak

Financ Res Lett. 2020 Oct:36:101744. doi: 10.1016/j.frl.2020.101744. Epub 2020 Sep 2.

Authors

Shi Chen¹, Yang Yang¹, Jyh-Horng Lin²

Affiliations

¹ School of Economics, Southwestern University of Finance and Economics, Chengdu 611130, China.
² Department of International Business, Tamkang University, New Taipei City, Taiwan.

Abstract

In this paper, we apply the risk-neutral valuation methodology to evaluate a life insurer's equity. We model the features capped by the explicit treatment of the borrowing firm's credit risk, the optimal guaranteed rate-setting, and the coronavirus disease (COVID-19) outbreak. The results show that the severe effect of the COVID-19 epidemic on the borrowing firm harms its insurance business but that stringent capital regulation helps. The severe impact of COVID-19 on both the borrowing firm and the insurer hedging harm policyholder protection, thereby adversely affecting insurance stability.

Keywords: COVID-19; Capital regulation; Capped barrier; Hedging; Policyholder protection.