The Bond-Pricing Implications of Rating-Based Capital Requirements

Scott Murray and Stanislava (Stas) Nikolova

Journal of Financial and Quantitative Analysis, 2022, vol. 57, issue 6, 2177-2207

Abstract: This article demonstrates that rating-based capital requirements, through their impact on insurers’ investment demand, affect corporate bond prices. Consistent with insurers’ low demand for investment-grade bonds with a rating close to noninvestment-grade, these bonds outperform. Consistent with insurers’ high (low) demand for investment-grade bonds with high (low) systematic risk exposure, these bonds underperform (outperform). Insurer demand, measured by insurer holdings, explains most of these pricing effects. We identify rating-based capital requirements as the driver of insurer demand, and thus the pricing effects, by showing that the effects do not exist before these requirements’ implementation in 1993.

Date: 2022
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