The Birth of Insurance Contracts - The Ataturk Institute for Modern ...

More documents

Recommendations

Info

Evidence 2: According to Lane (1973), the Nautical Revolution (1290-1350) reduced the cost of trading (k lower) Evidence 3: The Black Death increased per-capita income (k2 higher) Evidence 4: Interest rates on bank deposits and government bonds decreased dramatically (from 20-25 percent in the 12th century to about 2 percent in the 14th century). This suggests an increase in the availability of capital (k2 higher) Evidence 5: Byrne, de Roover, Lane, and Lopez agrees on the decrease of the marine risk circa the 14th century. Munro (1991), however, argues that the widespread warfare and disruptions of trade around 1300, which raised the level of risk, may have also contributed to the emergence of marine insurance. Evidence 6: Evolution E[x] = p¯x ¯x + px x. There is consensus that ¯x began to decrease by the mid or late 13th century, but it seems that p¯x, so that the aggregate effect is unclear. According to Lopez (p.97): ”Later, competition forced down the average profit, but greater security and the widening of the market enabled careful managers to increase their assets more steadily than ever before.” 4 Conclusions This paper combines a mechanism-design model and historical evidence to examine the evolution of financial contacts for overseas trade from the eleventh to the fifteenth century. Initially, merchants funded part of their ventures but raised additional capital through limited liability sea loans and commenda contracts. By the early fifteenth century, however merchants typically funded their ventures through risk-free bills of exchange and get insurance through premium policies. This changing financial structure can be rationalized as being determined to achieve the optimal allocation of risk while minimizing enforcement costs. The extent to which these factors are relevant today is indicated by the generality of the model’s assumptions and results. First, two-side risk aversion. Historically, significant indivisibilities and aggregate risk limited 22
the agents’ ability to diversify, preventing them from effectively becoming risk neutral. Today, most companies have a large share-holder who is not well-diversified (Zingales, 2000, p. 1628). Risk-aversion, because of limited risk-pooling, is typically assumed when dealing with the myriad of young and small firms who do not have access to public markets, such as individual propri- etorships, partnerships and closely-held corporations. Even when the financial capital is held by well-diversified investors, large widely-held corporations might still act in a risk-averse manner because the human capital invested in the firm is not well-diversified (Zingales, 2000); the firm’s managers faces some kind of bankruptcy costs (Greenwald and Stiglitz, 1990); managerial com- pensation is aligned with shareholders wealth maximization (Smith and Stulz, 1985); or there exist proprietary information (De Marzo and Duffie, 1991). Furthermore, although various works on Transaction Costs Economics have recently criticized risk-sharing arguments on account of their lack of empirical significance (mainly for labor contracts), Ackerberg and Botticini (2002) shows that risk aversion appears to influence contract choice when controlling for endogenous matching. Second, limited contract enforceability. Historically, enforcing payments from the agents’ private wealth was more costly than from the venture’s returns since, on the one hand, neither effective registration systems nor joint-stock insurance companies had yet developed and, on the other hand, the State fairly controlled sea ventures. Today, enforcement costs arguably cause banks’ reluctance to go through bankruptcy procedures for recovering loans from the debtors’ personal wealth (collateral). Similarly, an insurance company runs administrative cost greater than those of a capital market where bonds and equity are traded. It can therefore be reasonably argued that credit and insurance are optimally provided through the capital structure, rather than separately through risk-free debt from a bank and premium policies from an insurance company, because of enforcement costs. Thus, the model complements the optimal portfolio selection theory, which explains the holding of equity by both entrepreneurs and outsiders in terms of managerial risk aversion but ignores other contracts through which an outsider can potentially provide the same risk allocation. 23
Page 1 and 2: 1 Introduction The Birth of Insuran
Page 3 and 4: of hostile people, and to the inves
Page 5 and 6: utility from second-date consumptio
Page 7 and 8: in his enterity. In return for some
Page 9 and 10: ci(s) ≥ 0 ∀i, ∀s (3) ci(s)
Page 11 and 12: financier for the entire capital re
Page 13 and 14: power U 2. 10 It is worth to note,
Page 15 and 16: of budget constraints (k1 = 0). How
Page 17 and 18: project is highly costly and risky
Page 19 and 20: parties commit part of their wealth
Page 21: commenda) because the high risk and
Page 25 and 26: It is proved below that at a soluti
Page 27 and 28: Show that dc2(y) d(k2−k) = −
Page 29 and 30: Program 3 is concave so that Kuhn-T
Page 31 and 32: When the entrepreneur lacks the wea
Page 33 and 34: [10] González de Lara, Y. “The S
Page 35 and 36: FIGURE 1 (Hidden Information, k1 =
Page 37: c1(y) ✛ FIGURE 5 (k1 > k, Two-sid

The Birth of Insurance Contracts - The Ataturk Institute for Modern ...

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?