Risk Overhang and Market Behavior

We show that exposure from past business transactions risk overhang can reduce activity in related business lines, sometimes to the point where no new trade occurs. Our primary focus is the nonlife insurance market, where our model predicts that the relative impact, duration, and character of supply disruptions are related to the extent of overhang. These predictions are consistent with differences between the mid-1980s liability insurance crisis and the early-1990s catastrophe reinsurance crisis. We also discuss applications of our overhang model to disruptions in lending and securities markets.