On the cost-of-capital rate under incomplete market valuation

Hansjörg Albrecher*, Karl Theodor Eisele, Mogens Steffensen, Mario V. Wüthrich

*Corresponding author for this work

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Abstract

In this paper we discuss the concept of the cost-of-capital (CoC) rate for an insurance company as an equilibrium in the economic triangle of policyholders, shareholders, and the regulator. This provides a possible rationalization and an economic foundation for a quantity that is widely used in practice but whose value is typically neither technically nor economically well justified. We show how it can be well founded in such a triangular equilibrium. Under a simple one-period model and a valuation procedure of a two-price economy for illiquid assets we provide a corresponding economic-theoretical quantification for the CoC rate. The resulting rates are illustrated by a number of concrete numerical examples.

Original languageEnglish
JournalJournal of Risk and Insurance
Volume89
Pages (from-to)1139–1158
Number of pages20
ISSN0022-4367
DOIs
Publication statusPublished - 2022

Bibliographical note

Publisher Copyright:
© 2022 The Authors. Journal of Risk and Insurance published by Wiley Periodicals LLC on behalf of American Risk and Insurance Association.

Keywords

  • cost of capital
  • insurance
  • risk margin
  • solvency capital requirements
  • valuation

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