Investment Commonality across Insurance Companies: Fire Sale Risk and Corporate Yield Spreads

52 Pages Posted: 31 Mar 2016 Last revised: 27 Nov 2018

See all articles by Vikram K. Nanda

Vikram K. Nanda

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Wei Wu

Cal Poly Pomona

Xing (Alex) Zhou

Board of Governors of the Federal Reserve System

Date Written: March 1, 2016

Abstract

Insurance companies often follow highly correlated investment strategies. As major investors in corporate bonds, their investment commonalities subject investors to fire-sale risk when regulatory restrictions prompt widespread divestment of a bond following a rating downgrade. Reflective of fire-sale risk, clustering of insurance companies in a bond has significant explanatory power for yield spreads, controlling for liquidity, credit risk and other factors. The effect of insurer clustering on bond yield spreads is more evident for bonds held to a greater extent by capital-constrained insurance companies, those with ratings closer to National Association of Insurance Commissioners (NAIC) risk-categories with larger capital requirements, and during the financial crisis.

Keywords: yield spread, fire sales, correlated investment strategies, regulation, credit rating, corporate bonds, insurance companies, capital constraints

JEL Classification: G11, G12, G18, G22

Suggested Citation

Nanda, Vikram K. and Wu, Wei and Zhou, Xing (Alex), Investment Commonality across Insurance Companies: Fire Sale Risk and Corporate Yield Spreads (March 1, 2016). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2755343 or http://dx.doi.org/10.2139/ssrn.2755343

Vikram K. Nanda

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States

Wei Wu (Contact Author)

Cal Poly Pomona ( email )

3801 W Temple Ave
Pomona, CA 91768
United States

Xing (Alex) Zhou

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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