Investment Commonality across Insurance Companies: Fire Sale Risk and Corporate Yield Spreads
52 Pages Posted: 31 Mar 2016 Last revised: 27 Nov 2018
Date Written: March 1, 2016
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
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