Research

Financial intermediaries pool and diversify risk on their balance sheets, yet evidence that investors value this function is scarce. Studying insurers' bond investments, I provide evidence that investors value intermediaries’ diversification when transaction costs constrain their ability to diversify. I document that small, constrained insurers acquire larger shares of financial intermediaries' bonds ("financial bonds") than of comparable non-financial bonds. For a causal interpretation, I show that this preference for financial bonds declines sharply after a regulatory reform expanded insurers' access to bond exchange-traded funds. These results support a central theme in financial intermediation theory: intermediaries create value through diversification.

We document a novel transmission channel of monetary policy through the homeowners insurance market. On average, contractionary monetary policy shocks result in higher homeowners insurance prices. Using granular data on insurers' balance sheets, we show that this effect is driven by the interaction of financial frictions and the interest rate sensitivity of investment portfolios. Specifically, rate hikes reduce the market value of insurers' assets, tightening insurers' balance sheet constraints and increasing their shadow cost of capital. These frictions in insurance supply amplify the effects of monetary policy on real estate and mortgage markets by making housing less affordable. We find that monetary policy shocks have a stronger impact on home prices and mortgage applications when local insurers are more sensitive to interest rates. This channel is particularly pronounced in areas where households face high climate risk exposure. Our findings highlight the role of insurance markets in amplifying macroeconomic shocks and the interconnections between homeowners insurance, residential real estate, and mortgage lending.

Close-out netting is a standard procedure in derivatives markets that protects counterparties' claims on derivatives contracts. Despite the ubiquitous nature in derivatives markets, the literature has not studied counterparties' motivation to use close-out netting. This paper aims to fill this gap. I develop a theoretical model and interpret close-out netting as the option to make a derivative state-dependent. I show that firms use close-out netting as a tool to transfer risk from derivatives counterparties to creditors. Whether the risk-transfer is sub-optimal, however, depends on the type of the derivative. In the case of additional risk sources that make the derivative an imperfect hedge, close-out netting can protect firms' creditors from counterparty risk. The findings of this paper are in line with prior evidence on derivatives contracts and their use in bankruptcy cases.