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

Nanda, Vikram; Wu, Wei; Zhou, Xing

doi:10.17016/FEDS.2017.069

Working Paper

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

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 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 spreads;

JEL Classification: G11; G12; G18; G22;

https://doi.org/10.17016/FEDS.2017.069