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Reaching for Yield in the Bond Market

54 Pages Posted: 24 May 2012 Last revised: 18 Mar 2014

Bo Becker

Stockholm School of Economics; Centre for Economic Policy Research (CEPR)

Victoria Ivashina

Harvard University; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: October 12, 2013

Abstract

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.

Keywords: Reaching for yield; Financial crises; Credit cycles; Insurance companies

JEL Classification: G11, G22, G30

Suggested Citation

Becker, Bo and Ivashina, Victoria, Reaching for Yield in the Bond Market (October 12, 2013). Journal of Finance, Forthcoming; Harvard Business School Finance Working Paper No. 12-103. Available at SSRN: https://ssrn.com/abstract=2065841 or http://dx.doi.org/10.2139/ssrn.2065841

Bo Becker (Contact Author)

Stockholm School of Economics ( email )

Drottninggatan 98
Dept. of Finance
111 60 Stockholm, 11160
Sweden

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Victoria Ivashina

Harvard University ( email )

Harvard Business School
Baker Library 233
Boston, MA 02163
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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