Abstract
In this paper, the three-period incomplete contract model with the liquidity constraint is formulated to investigate why the risk neutral firms are motivated to hold the insurance against the seismic risk. If an earthquake attacks a firm within the period that it does not have prepared the sufficient liquidity for the recovery form seismic loss, the firm is forced to procure the necessary money from the capital market. However, if the firm are endowed with the large amount of debt, it is faced with the difficulty to procure the additional money ; i.e., the debt overhang issues. The earthquake insurance is expected to function as the vehicle to overcome thedebt overhang issues. The paper also investigates the moral hazard issues caused by holding the earthquake insurance, and presents the Finite insurance schemes to overcome the moral hazard issues and debt overhang issues.
