Impact of Rating Standards on Risk-Taking of Financial Institutions: Evidence from Catastrophe Risks in Insurance

65 Pages Posted: 8 Dec 2013 Last revised: 25 Feb 2021

See all articles by Christoph Basten

Christoph Basten

University of Zurich; Swiss Finance Institute; CESifo (Center for Economic Studies and Ifo Institute)

Anastasia V. Kartasheva

University of St. Gallen - I.VW-HSG; Joshua J. Harris Alternative Investment Program

Sojung Carol Park

California State University, Fullerton - Department of Finance; University of Pennsylvania - Applied Economics Department, The Wharton School

Date Written: October 15, 2019

Abstract

We analyze how financial institutions adjust their risk-taking in response to stricter rating standards. Building on the premise that the demand for financial institutions services depends on their financial strength which is communicated by a rating, we argue that a more stringent rating standard induces a differential response. Financial institutions facing high (low) elasticity of demand to ratings and moderate (high) cost of raising capital improve (weaken) their financial strength in response to a stricter rating standard. We empirically assess the response to stricter standards using a significant change of the rating methodology for catastrophe risk exposures of insurers in the aftermath of hurricane Katrina. We find the differential response, revealing that lower financial strength insurers serving customers with low elasticity of demand to financial strength became more risky in response to the standard change.

Keywords: credit rating agencies, rating standards, insurance, catastrophic risk

JEL Classification: G22, G24, G31

Suggested Citation

Basten, Christoph and Kartasheva, Anastasia V. and Park, Sojung Carol, Impact of Rating Standards on Risk-Taking of Financial Institutions: Evidence from Catastrophe Risks in Insurance (October 15, 2019). Available at SSRN: https://ssrn.com/abstract=2364734 or http://dx.doi.org/10.2139/ssrn.2364734

Christoph Basten

University of Zurich ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

Swiss Finance Institute

c/o University of Geneva
40 Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Anastasia V. Kartasheva (Contact Author)

University of St. Gallen - I.VW-HSG ( email )

Kirchlistrasse 2
St. Gallen, 9010
Switzerland

Joshua J. Harris Alternative Investment Program ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

Sojung Carol Park

California State University, Fullerton - Department of Finance ( email )

PO Box 34080
Fullerton, CA 92834-9480
United States

University of Pennsylvania - Applied Economics Department, The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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