Insurance and Corporate Risk Management

Abstract

This paper provides a model of a competitive financial market economy in which there are not only stock and bond markets but also insurance markets. In the model's most naive form, the analysis shows that the corporate value of the insured firm equals that of the uninsured firm and in this case the firm has no active role to assume in managing corporate risk. The model is then modified to incorporate costly bankruptcy and agency problems. Then the analysis shows that the corporation has an incentive to purchase insurance because it may eliminate or reduce the bankruptcy and/or agency costs.