Reaching for Yield in the Bond Market

Abstract

This paper studies reaching for yield—investors’ propensity to buy riskier assets to achieve higher yields—in the corporate bond market. We show that insurance companies reach for yield in choosing their investments. Consistent with lower rated bonds bearing higher capital requirements, insurance firms prefer to hold higher rated bonds. However, conditional on credit ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds. This behavior is related to the business cycle being most pronounced during economic expansions. It is also characteristic of firms with poor corporate governance and for which the regulatory capital requirement is more binding.