Working Paper: NBER ID: w25677
Authors: Shan Ge; Michael S. Weisbach
Abstract: Many institutional investors depend on the returns they generate to fund their operations and liabilities. How do these investors’ financial conditions affect the management of their portfolios? We address this issue using the insurance industry because insurers are large investors for which detailed portfolio data are available, and can face financial shocks from exogenous weather events that help us establish causality. Among corporate bonds, for which we can control for regulatory treatment, results suggest that when Property & Casualty (P&C) insurers become more constrained due to operating losses, they shift towards safer bonds. The effect of losses on allocations is likely to be causal since it holds when instrumenting for losses with weather shocks. The change in allocations following losses is larger for smaller or worse-rated insurers and during the financial crisis, suggesting that the shift toward safer securities is driven by concerns about financial flexibility. The results highlight the importance of financial conditions in institutional investors’ portfolio decisions.
Keywords: portfolio management; financial constraints; insurance; causal inference; weather shocks
JEL Codes: G11; G21; G22; G31; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Operating losses (G33) | Shift towards safer corporate bonds (G32) |
| Unusual weather damages (Q54) | Operating losses (G33) |
| Operating losses (G33) | Financial constraints (D10) |
| Financial constraints (D10) | Shift towards safer corporate bonds (G32) |
| Financial conditions (E66) | Portfolio choices (G11) |
| Operating losses (G33) | Safer and more liquid securities (G10) |