Investment Commonality Across Insurance Companies: Fire Sale Risk and Corporate Yield Spreads
56 Pages Posted: 4 Jul 2017
Date Written: 2017-06-28
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 fire-sale risk on bond yield spreads is more evident for bonds held to a greater extent by capital-constrained insurance companies, those with ratings closer to NAIC risk-categories with larger capital requirements, and during the financial crisis.
Keywords: Capital constraints, Corporate bonds, Credit rating, Fire sales, Insurance companies, Regulation, Yield spread
JEL Classification: G11, G12, G18, G22
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