A contingent claim model of life insurer-bank swap default pricing: strategic substitutes and complements. Issue 36 (2nd August 2021)

• Record Type: Journal Article
• Authors: Lin, Jyh-Horng; Chen, Shi; Huang, Fu-Wei
• Is Part Of: Applied economics. Volume 53:Issue 36(2021)
• Page Start: 4166
• Page End: 4177
• Publication Date: 2021-08-02
• Subjects: Swap transactions -- strategic complement -- strategic substitute -- capital regulation; G21 -- G22; Economics -- Periodicals; 330
• DOI: 10.1080/00036846.2021.1897077
• Languages: English
• ISSNs: 0003-6846

Abstract

ABSTRACT: This paper develops a contingent claim framework to examine swap transactions between a life insurer and a bank that bilaterally price default risks. We show that the insurer (the protection buyer in the swap transaction market) regards the optimal bank loan rate as a strategic complement. In contrast, the bank (the protection seller) considers the optimal insurer guaranteed rate as a strategic substitute. Hedging conducted by the insurer enhances profits but hurts policyholder protection. Bank capital regulation harms policyholder protection. Insurer capital regulation leads to bank risk-taking. Capital regulations, as such, would jeopardize insurer-bank performance from a financial stability standpoint.