DP16322 Insurance Companies and the Propagation of Liquidity Shocks to the Real Economy

Author(s): Yubo Liu, Stefano Rossi, Hayong Yun
Publication Date: July 2021
Keyword(s): fire sales, Insurance companies, market liquidity, Natural Disasters, public and private investment, reinsurance
JEL(s): E22, G14, G22, G31, G32
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16322

We study the role of insurance companies in propagating liquidity shocks to the real economy. We use natural disasters as our instrument to identify exogenous shifts in capital-market liquidity, and study whether capital-market liquidity affects regional-level fiscal conditions and output. Aggregate disaster-driven bonds sales of disaster-unaffected municipal bonds by exposed insurers cause low GDP growth and high unemployment. In micro data, natural disasters trigger large, unexpected redemptions of property-insurance contracts, causing: fire sales of municipal bonds; increased borrowing costs in primary markets; decreased muni issuance; lower investment in muni-reliant sectors. Therefore, insurance companies do propagate liquidity shocks to the real economy.