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Reaching for yield—the 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 analyses this phenomenon in the corporate bond market. Specifically, we show evidence for reaching for yield among insurance companies, the largest institutional holders of corporate bonds. Insurance companies have capital requirements tied to the credit ratings of their investments. Conditional on ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds. This behavior appears to be related to the business cycle, being most pronounced during economic expansions. It is also more pronounced for the insurance firms for which regulatory capital requirements are more binding. The results hold both at issuance and for trading in the secondary market and are robust to a series of bond and issuer controls, including issuer fixed effects as well as liquidity and duration. Comparison of the ex-post performance of bonds acquired by insurance companies does not show outperformance but higher volatility of realized returns.

This paper studies a Diamond–Dybvig model of providing insurance against unobservable liquidity shocks in the presence of unobservable trades. We show that competitive equilibria are inefficient. A social planner finds it beneficial to introduce a wedge between the interest rate implicit in optimal allocations and the economy's marginal rate of transformation. This improves risk sharing by reducing the attractiveness of joint deviations where agents simultaneously misrepresent their type and engage in trades on private markets. We propose a simple implementation of the optimum that imposes a constraint on the portfolio share that financial intermediaries invest in short-term assets., Economics