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

56 Pages Posted: 4 Jul 2017

See all articles by Vikram K. Nanda

Vikram K. Nanda

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Wei Wu

California State Polytechnic University, Pomona

Xing (Alex) Zhou

Board of Governors of the Federal Reserve System

Date Written: 2017-06-28

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

JEL Classification: G11, G12, G18, G22

Suggested Citation

Nanda, Vikram K. and Wu, Wei and Zhou, Xing (Alex), Investment Commonality Across Insurance Companies: Fire Sale Risk and Corporate Yield Spreads (2017-06-28). FEDS Working Paper No. 2017-069, Available at SSRN: https://ssrn.com/abstract=2995872 or http://dx.doi.org/10.17016/FEDS.2017.069

Vikram K. Nanda (Contact Author)

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States

Wei Wu

California State Polytechnic University, Pomona

3801 W. Temple Avenue
Pomona, CA 91768
United States

Xing (Alex) Zhou

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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