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

  • Vikram Nanda, Wei Wu and Xing (Alex) Zhou

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, the 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 insurer clustering on bond yield spreads is more evident for bonds held to a greater extent by capital-constrained insurance companies, those with ratings closer to National Association of Insurance Commissioners risk categories with larger capital requirements, and during the financial crisis.

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Copyright

Corresponding author

*Nanda (corresponding author), vikram.nanda@utdallas.edu, University of Texas at Dallas Jindal School of Management; Wu, weiwu@cpp.edu, California State Polytechnic University at Pomona College of Business Administration; and Zhou, xing.zhou@frb.gov, Federal Reserve Board of Governors.

Footnotes

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1

This paper reflects the views of the authors only and not necessarily those of the Board of Governors, other members of its staff, or the Federal Reserve System. The authors thank Kathleen Hanley (Western Finance Association (WFA) discussant), Rongbing Huang (Financial Management Association (FMA) discussant), Richard Rosen, Paul Schultz (the referee), Jason Wei, participants at the 2017 WFA annual conference, the 2016 FMA annual conference, Bank of International Settlements (BIS) Workshop on Systemic Stress, Investor Behavior, and Market Liquidity, and seminar participants at the University of California at Irvine, the Office of the Comptroller of the Currency, California State Polytechnic University at Pomona, and New Jersey Institute of Technology.

Footnotes

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

  • Vikram Nanda, Wei Wu and Xing (Alex) Zhou

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