Insurance Risk Analysis of Financial Networks
We conduct a quantitative risk analysis of non-core insurance business of selling financial products to protect financial firms against investment losses due to a shock. To achieve the goal, we construct a static structural model composed of a network of firms who cross-hold each other, multiple primitive assets that are vulnerable to a shock, and an insurer who resides external to the network and speculates in selling protection to financial firms. Assume that each firm in the network is rational and able to decide how much protection to purchase to optimize its portfolio according to the mean-variance principle. As a result, the shock may impact the insurer but indirectly through the network, and thus both the network integration and the shock are risk factors of this non-core insurance business. Our study focuses on describing their interactive role in the insurance risk. Depending on the shock size, an increase in the network integration (which refers to the level of exposures of firms to each other) may help reduce the insurance risk, or drive the insurer to a more profitable position, or hinder the insurer from making profit.
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