Paul Ehling

Corporate Insurance and Managers' and Owners' Risk Aversion

I study corporate risk management with property insurance in non-listed small and medium sized rms. I document a positive relation between CEO salary and insurance use, and negative relations between CEO ownership and insurance use and between ownership concentration and insurance-use. The rst relation is consistent with risk aversion by managers as insurance motive. The second and third relations are consistent with overinsurance relative to other rms as well as with self-insurance among CEO-controlled rms, given monopolistic insurance premium pricing practices. It is also consistent with a lack of incentive for CEOs (owners) with large ownership to hedge states with too low cash ow. However, these relations hold only for rms with zero long-term debt. In addition, non-listed rms insure (hedge), as do listed rms, in order to increase their debt capacity. Finally, I nd that insurance use exerts a positive in uence on corporate liquidity. Importantly, I also nd that the insurance-liquidity relation runs the other way: that is, liquidity exerts a positive in uence on insurance-use. Speci cally, the endogenous relation between cash, debt, and insurance is more relevant for rms with positive long-term debt.

Asset Prices and Portfolio Choice with Learning from Experience

We study asset prices and portfolio choice with overlapping generations, where the young disregard history to learn from own experience. Disregarding history implies less precise estimates of output growth, which in equilibrium leads the young to increase their investment in risky assets after positive returns, that is, they act as trend chasers. In equilibrium, the risk premium decreases after a positive shock and, therefore, trend chasing young agents lose wealth relative to old agents who behave as contrarians. Consistent with findings from survey data, the average belief about the risk premium in the economy relates negatively to future excess returns and is smoother than the true risk premium.

Complete and Incomplete Financial Markets in Multi-Good Economies

We investigate conditions for endogenous incompleteness and completeness in continuous-time financial markets driven by diffusion processes with multiple consumption goods and heterogeneous agents. We show that for a class of utility functions the financial market is endogenously incomplete. A sufficient condition for market completeness is that the dividend diffusion matrix in units of the numeraire good is invertible. Further, financial market completeness can depend on the choice of the numeraire good since changing the numeraire good implies a change of the risk-free asset and the asset structure.

Risk Aversion Sensitive Real Business Cycles

Technology choice allows for substitution of production across states of nature and depends on state dependent risk aversion. In equilibrium, endogenous technology choice can counter a persistent negative productivity shock with an increase in investment. An increase in risk aversion intensifies transformation across states, which directly leads to higher investment volatility. In our model and the data, the conditional volatility of investment correlates negatively with the price-dividend ratio and predicts excess stock market returns. In addition, the same mechanism generates predictability of consumption and produces fluctuations in the risk-free rate.

When Does Cash Matter? Evidence for Private Firms

Using a database of more than 180,000 private companies from 2000 to 2009, we find that the benefits of holding more cash vary substantially with a firm’s size and the conditions it faces. Cash holdings matter most for small firms: when there are negative shocks to industry or macroeconomic conditions, a small firm’s cash holdings are positively associated with changes in its sales and assets. Cash is less important for other conditions. Differences in the benefits of cash holdings between large and small firms are traced to a firm’s ability – and willingness – to increase leverage when there is a cash shortfall.

Portfolio Tax Trading with Carryover Losses

We study portfolio choice with multiple stocks and capital gain taxation assuming that capital losses can only offset current or future realized capital gains. We show through backtesting, using empirical distributions, that optimal equity holdings over an extended period are significantly lower on average than benchmark holdings suggested in the literature. Using Value and Growth or Small and Large portfolios, the backtests show that allocations remain persistently under-diversified. Carry-over losses have large economic significance since they can dramatically shrink the no-trade region. Finally, the backtested economic cost of incorrectly modeling capital losses is at least 8 percent of lifetime wealth.

Agency and Corporate Purchase of Insurance

Consistent with the agency cost rational, this paper documents that managers having larger private benefits of control purchase more insurance to reduce their own exposure to the probability of left-tail outcomes and hence the volatility of the firms cash flows. Private benefits of control are estimated by the market value of the right to vote (measured as the difference between the price of the stock and an equivalent synthetic stock that is constructed with options). Our results hold when we control for the probability of a control contest. We also find that firms with larger private benefits of control tend to use more debt.