Regulatory Pressure and Fire Sales in the Corporate Bond Market
54 Pages Posted: 22 Mar 2009 Last revised: 12 May 2014
Date Written: February 28, 2011
This paper investigates fire sales of downgraded corporate bonds induced by regulatory constraints imposed on insurance companies. As insurance companies hold over one-third of investment-grade corporate bonds, the collective need to divest downgraded issues may be limited by a scarcity of counterparties. Using insurance company transaction data, we find that insurance companies that are relatively more constrained by regulation are more likely to sell downgraded bonds. Bonds subject to a high probability of regulatory-induced selling exhibit price declines and subsequent reversals. These price effects appear larger during periods when the insurance industry is relatively distressed and other potential buyers’ capital is scarce.
Keywords: Fire sales, Regulation, Price pressure, Liquidity, Corporate bonds, Insurance companies
JEL Classification: G11, G12, G14, G18, G22
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