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Review of Quantitative Finance and Accounting

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10.05.2024 | Original Research

CEO optimism and the use of credit default swaps: evidence from the US life insurance industry

verfasst von: Jiang Cheng, Hung-Gay Fung, Tzu-Ting Lin, Min-Ming Wen

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 1/2024

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Abstract

In this study, we examine the effects of the degree of CEO optimism on their risk-taking behaviors and on firm value and show that CEOs with low overconfidence tend to take on more risk (in terms of tail risk) and have a lower Tobin’s Q than companies whose CEOs have moderate or high overconfidence. To do so, we use a sample of life insurance companies divided into three subsamples, based on the degree of CEO overconfidence (OC): low OC, moderate OC, and high OC. Our additional analyses indicate that, before the 2008 global financial crisis, all three OC subsamples have a positive effect on Tobin’s Q from the net credit default swap (CDS) sell positions. But, after the financial crisis, all the three OC groups use CDS to reduce firms’ risk-taking behavior, rather than to increase firm value.

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Bakshi et al. (2022) explain the CDS definition as follows: CDS offers insurance against the possible default of a reference issuer. The contract specifies that the CDS seller compensates the CDS buyer in the event of default. In return, the CDS buyer pays a constant payment until the CDS maturity or a default.

Fung et al. (2012) highlight that the insurance industry is highly regulated at the state level, and it is mandatory for insurers to report their investment activities, including CDS transactions, in the regulatory statements filed with the National Association of Insurance Commissioners (NAIC). NAIC generally characterizes the application of CDS by insurance companies into hedging, replication, and income generation purposes.

Our use of OC variables does not create a multicollinearity problem because we use the estimated value of CEO optimism for the simultaneous inclusion of LOC, MOC, and HOC. We are not using a dummy variable for each CEO optimism group. We have also tested for multicollinearity, which seems not to be an issue. All the regression models have been controlled for the firm-fixed effects. We thank an anonymous referee for pointing this out.

In a robustness check, we also use 2008 and 2009 to define when the financial crisis occurred. The results are qualitatively similar and are available from the author upon request. We thank an anonymous referee for suggesting this to define the years of the global financial crisis more broadly.

To save space, we do not report the results for ES (99) here. They are available upon request.

We compare the coefficients and find a significant difference at the 5% level with an F-statistic of 6.61.

Using semistd as a risk measure, we find that the overall net effects on risks are qualitatively similar. The detailed calculation results, unreported here, are available from the author upon request.

The effects of 3.066 can be calculated by adding the main MOC_m effect (0.062) and the interaction term CDS_NetSell_MOC × MOC_m (6.796). The results of an overall MOC effect on risk of 0.062 + 6.796 × CDS NetSell_MOC, which has a mean of 0.4422 (as shown in Panel C of Table 1).

This is obtained by adding the CDS NetSell_MOC (-2.103) to its interaction term CDS NetSell_MOC × MOC_m (6.796). This results in a total marginal effect of MOC_m on risk of -2.103 + 6.796 × mean_value_CDS NetSell_MOC (0.0035381, as shown in Panel C of Table 1), resulting in a net negative effect of -2.076 (= -2.103 + 6.796 × 0.0035381 = -2.103 + 0.024).

The coefficient of LOC_m on risk is 0.098, and its interaction with CDS (CDS NetSell_LOC × LOC_m) is -1.85. The marginal effect of LOC_m on risk is 0.098, that is, -1.85 × CDS NetSell_LOC (which has a mean of 0.0041369 in the postcrisis period, in Panel C of Table 1).

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Titel: CEO optimism and the use of credit default swaps: evidence from the US life insurance industry
verfasst von: Jiang Cheng
Hung-Gay Fung
Tzu-Ting Lin
Min-Ming Wen
Publikationsdatum: 10.05.2024
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 1/2024
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-024-01254-8

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