Froot, Kenneth A. <br/><br/>
Risk Management, Capital Budgeting and Capital Structure Policy for Insurers and Reinsurers / 
Kenneth A. Froot. 
 - Cambridge, Mass.  National Bureau of Economic Research  2003. 
 - 1 online resource:  illustrations (black and white); 
 - NBER working paper series  no. w10184 .
 - Working Paper Series (National Bureau of Economic Research)  no. w10184. .
<br/><br/> December 2003. 
<br/><br/> This paper builds on Froot and Stein (1998) in developing a framework for analyzing the risk allocation, capital budgeting, and capital structure decisions facing insurers and reinsurers. The model incorporates three key features: i) value-maximizing insurers and reinsurers face product-market as well as capital market imperfections that give rise to well-founded concerns with risk management and capital allocation; ii) some, but not all, of the risks they face can be frictionlessly hedged in the capital market; iii) the distribution of their cashflows may be asymmetric, which alters the demand for underwriting and hedging. We show that these features result in a three-factor model that determines the pricing and allocation of risk and the optimal capital structure of the firm. This approach allows us to integrate these features into: i) the pricing of risky investment, underwriting, reinsurance, and hedging; and ii) the allocation of risk across all of these opportunities, and the optimal amount of surplus capital held by the firm. 
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