Liquidity risks and demands for earthquake insurances

In this paper, a three-period model with debt overhang is proposed to analyze the mechanism that a risk-neutral firm calls for earthquake insurance. If the firm needs to make an additional investment to continue operation due to an earthquake, the firm must procure liquidity assets immediately. However, the firm may confront debt-overhang problem, which mean that the firm cannot procure for the additional investment. This paper shows earthquake insurance can alleviate such a debt-overhang problem.