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

Vikram Nanda, Wei Wu and Xing Zhou

No 2017-069, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (US)

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 spread (search for similar items in EconPapers)
JEL-codes: G11 G12 G18 G22 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ias and nep-rmg
Date: 2017-06-28
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DOI: 10.17016/FEDS.2017.069

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