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The Bond-Pricing Implications of Rating-Based Capital Requirements

Published online by Cambridge University Press:  15 February 2021

Scott Murray  and
Stanislava Nikolova Open the ORCID record for Stanislava Nikolova [Opens in a new window]
Scott Murray
Affiliation:
Georgia State University Robinson College of Business smurray19@gsu.edu
Stanislava Nikolova*
Affiliation:
University of Nebraska–Lincoln College of Business
*
snikolova2@unl.edu (corresponding author)
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Abstract

This article demonstrates that rating-based capital requirements, through their impact on insurers’ investment demand, affect corporate bond prices. Consistent with insurers’ low demand for investment-grade bonds with a rating close to noninvestment-grade, these bonds outperform. Consistent with insurers’ high (low) demand for investment-grade bonds with high (low) systematic risk exposure, these bonds underperform (outperform). Insurer demand, measured by insurer holdings, explains most of these pricing effects. We identify rating-based capital requirements as the driver of insurer demand, and thus the pricing effects, by showing that the effects do not exist before these requirements’ implementation in 1993.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 6 , September 2022 , pp. 2177 - 2207
Copyright
© The Author(s), 2021. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

This article was the winner of the best paper award at the 2018 INQUIRE Europe and INQUIRE UK Joint Seminar. We thank an anonymous referee, Linda Allen, Brent Ambrose, Antje Berndt, Hendrik Bessembinder (the editor), Christian Biener, Robert Connolly, Jess Cornaggia, Jens Dick-Nielsen, Andrew Ellul, Peter Feldhütter, Mark Flannery, Nathan Foley-Fisher, Jon Garfinkel, John Geppert, Kathleen W. Hanley, Jean Helwege, Pab Jotikasthira, Dalida Kadyrzhanova, Anastasia Kartasheva, Marcus Opp, Farzad Saidi, Alessandro Sbuelz, Aurelio Vasquez, Jing Wang, Liying Wang, Julie Wu, and Hao Zhang; participants at the 2017 Conference on Financial Economics and Accounting, 2018 CONSOB/ESMA/Bocconi Conference, 2018 EFA Conference, 2018 INQUIRE Europe and INQUIRE UK Joint Seminar, 2018 FMA European Conference, 2019 Chicago Financial Institutions Conference, 2019 FDIC/JFSR Bank Research Conference, 2019 Fixed Income and Financial Institutions Conference, 2019 Mid-Atlantic Research Conference in Finance, 2019 Swiss Society for Financial Market Research Conference, and 2020 AFA Conference; and participants in seminars at Australian National University, Baruch College, Georgia State University, Instituto Tecnológico Autónomo de México, the U.S. Securities and Exchange Commission, Stony Brook University, Syracuse University, Universita Cattolica del Sacro Cuore, Universita Ca’ Foscari University, the University of Kansas, the University of Iowa, and the University of Nebraska–Lincoln for feedback that substantially improved this article. This work used the Extreme Science and Engineering Discovery Environment (XSEDE), which is supported by National Science Foundation grant no. ACI-1548562 (see Towns et al. (2014)).

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