Reaching for Yield in the Bond Market
Stockholm School of Economics
Harvard University; National Bureau of Economic Research (NBER)
October 12, 2013
Journal of Finance, Forthcoming
Harvard Business School Finance Working Paper No. 12-103
Reaching-for-yield — investors’ propensity to buy riskier assets in order to achieve higher yields—is believed to be an important factor contributing to the credit cycle. This paper presents a detailed study of this phenomenon in the corporate bond market. We show that insurance companies, the largest institutional holders of corporate bonds, reach for yield in choosing their investments. Consistent with lower rated bonds bearing higher capital requirement, insurance firms’ prefer to hold higher rated bonds. However, conditional on credit ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds. Reaching-for-yield exists both in the primary and the secondary market, and is robust to a series of bond and issuer controls, including bond liquidity and duration, and issuer fixed effects. This behavior is related to the business cycle, being most pronounced during economic expansions. It is also more pronounced for firms with poor corporate governance and for which the regulatory capital requirement is more binding. A comparison of the ex-post performance of bonds acquired by insurance companies shows no outperformance, but higher systematic risk and volatility.
Number of Pages in PDF File: 54
Keywords: Reaching for yield; Financial crises; Credit cycles; Insurance companies
JEL Classification: G11, G22, G30
Date posted: May 24, 2012 ; Last revised: March 18, 2014
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