Insurance and Interconnectedness in the Financial Services Industry

As with other studies, we observe that most financial service companies are affected by a
market or industry factor, which is generally the largest principal component when analyzing returns to
financial service firms. As with other studies, we also find that there is a second factor, and we propose
an explanation for this factor; we posit that this factor represents the diversification potential of the
financial service industry, as proxied by the variance of the correlations among the financial service
portfolios. We also find that insurance companies are related to third and fourth principal components,
which is consistent with other studies.
We also examine the possibility of feedback, either unidirectional or bidirectional, among the
types of financial services companies. We use tests of Granger causality to examine the relation among
the current, lagged, and lead monthly returns. We find that the causality attributed to the insurance
industry by other studies is most likely driven primarily by financial guarantee and life insurers.
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