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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Investment Commonality across Insurance Companies : Fire Sale Risk and Corporate Yield Spreads
Vikram Nanda
Wei Wu
Xing Zhou
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.


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Vikram Nanda & Wei Wu & Xing Zhou, Investment Commonality across Insurance Companies : Fire Sale Risk and Corporate Yield Spreads, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2017-069, 28 Jun 2017.
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Keywords: Capital constraints ; Corporate bonds ; Credit rating ; Fire sales ; Insurance companies ; Regulation ; Yield spread
DOI: 10.17016/FEDS.2017.069
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