Systemic Risk, Financial Crisis, and Credit Risk Insurance

Date01 August 2013
Published date01 August 2013
The Financial Review 48 (2013) 417–442
Systemic Risk, Financial Crisis, and Credit
Risk Insurance
Fang Chen
University of New Haven
Xuanjuan Chen
Shanghai University of Finance and Economics
Zhenzhen Sun
Siena College
Tong Yu
University of Rhode Island
Ming Zhong
Shanghai University of Finance and Economics
Differing from conventional insurance firms whose underwriting business does not con-
tribute to systemic risk, credit risk insurance companies providing credit protections for debt
obligations are exposed to systemic risk. We show that credit risk insurers (CRIs) underper-
formed conventional insurance companies during the 2007–2009 financial crisis, and such
underperformance is attributed to the greater systemic risk of CRIs. Wealso find that the credit
Corresponding author: School of Finance, Shanghai University of Finance and Economics, 100
WuDong Road, Shanghai, China 200433; Phone: (8621)65904556; Fax: (8621) 65103925; E-mail:
We thank Andre Liebenberg, Robert Van Ness (the editor), two anonymous referees, and the participants
of the 2010 World Risk and Insurance Economics Congress Meetings and the 2011 FMA meetings for
helpful insights and comments. All errors are our own.
C2013, The Eastern Finance Association 417
418 F.Chen et al./ The FinancialReview 48 (2013) 417–442
spreads of insured bonds increase significantly after their insurers are downgraded or put in
the negative watch list. We control for alternative factors affecting bond credit spreads and the
result is robust.
Keywords: s ystemicrisk, credit risk insurers, financial crisis
JEL Classifications: G01, G12, G22
1. Introduction
Considered an event occurring “once-in-a-century” (Greenspan, 2009), the
2007–2009 financial crisis caused unprecedented losses to the financial market. Trig-
gered by the collapse of the U.S. housing market, the financial crisis developed into a
systemic event resulting in wide spread defaults of the real economy and large drops
in security markets around the world. While the limelight was on titanic losses in
the mortgage markets and the banking sector, few would disagree on the significant
role played by the American International Group (AIG) in the crisis due to its in-
volvement and losses from the credit default swaps (CDS) business. In addition to
AIG, financial guaranty insurers (FGIs) that insure mortgage/asset backed securities
were badly hit by the crisis. Yet, none of the extant studies have thoroughly exam-
ined the role of insurance firms that provide credit risk protection in the financial
We first examine how credit risk insurers (CRIs) are affected by their exposure
to systemic risk during the 2007–2009 financial crisis. CRIs are firms that provide
financial guaranty and write CDS. Based on the Geneva Association (2010), FGIs
covered 2.3 trillion USD of financial assets in 2007. The notional value of CDS
contracts written by multiline and monoline insurers is also substantial: at the end
of 2006, the notional value of CDS written by insurers was around 1.4 trillion USD
(Geneva Association, 2010). A common feature of FGIs and insurers writing CDS
is that they potentially have a strong link with the financial system, and the loss of
securities under protection would be transmitted to the loss of associated insurers very
We document that CRIs experience much worse stock and operating perfor-
mance than other insurers in the crisis. Note that systemic risk is considered the
collapse of the market due to a breakdown in the financial system. We attribute the
1Acharya, Biggs, Richardson and Ryan (2010) investigatethe role of the financial regulations on mitigating
systemic risk in the insurance sector.Billio, Getmansky, Lo and Pelizzon (2010) examine the measurement
of the systemic risk among the finance and insurance sector due to its interconnectedness. Cummins and
Weiss (2011) and Grace (2010) examine systemic risk for all property and life insurers while Harrington
(2009) focuses solely on AIG. None of the extant works study the experience of credit risk insurance
sector during the crisis.

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT