Working Paper: NBER ID: w18909
Authors: Bo Becker; Victoria Ivashina
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 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; Insurance companies; Corporate bonds; Credit cycles; Systemic risk
JEL Codes: G11; G22; G30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Insurance companies' capital requirements (G22) | propensity to invest in higher yield bonds (G11) |
| Reaching for yield (G11) | higher yielding bonds within the same regulatory risk categories (G12) |
| Reaching for yield (G11) | higher fraction of bonds in the highest yield quartile (G12) |
| Reaching for yield (G11) | systematic bias towards risky assets (G41) |
| Reaching for yield (G11) | procyclical behavior during economic expansions (E32) |
| Reaching for yield (G11) | higher systematic risk and volatility (G12) |
| Insurance companies' investment patterns (G22) | correlation with credit issuance volumes (E51) |
| Reaching for yield (G11) | misallocation of credit supply (E51) |