Information Risk and the Cost of Capital

Information Risk and the Cost of Capital

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Article ID: iaor201522213
Volume: 81
Issue: 4
Start Page Number: 861
End Page Number: 882
Publication Date: Dec 2014
Journal: Journal of Risk and Insurance
Authors: , ,
Keywords: statistics: empirical, risk, information
Abstract:

This article applies a unique accruals measure to empirically test whether accruals quality affects the cost of capital for property–liability insurers. We utilize insurer loss reserve errors to accurately measure the quality of accruals. This measure, as well as conventional accruals measures, is used to investigate the extent to which accruals quality is priced into both debt and equity capital. We find that accruals quality is priced into debt capital; however, we find virtually no evidence that accruals quality is priced into equity capital. Our results should be of particular interest to insurers as it affects pricing ability. Specifically, insurers who provide primary debtholders (i.e., policyholders) less information risk are able to command higher prices. Furthermore, our results suggest that insurance is not a diversifiable asset.

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