Abstract: Post-2008, corporate bond credit spreads decline when long-term interest rates increase, particularly for lower-rated bonds. This is true unconditionally but also conditional on monetary policy announcements. In the cross-section, this negative co-movement between long rates and credit spreads is more pronounced for bonds predominantly held by life insurers. I develop a quantitative framework that rationalizes these findings. In the model, life insurers with long-duration liabilities face duration mismatch and therefore realize equity gains when long rates increase. As a result, their effective risk aversion declines, driving down equilibrium credit spreads. The model explains the majority of the empirical credit spread responses to long rates. The model also shows that life insurers' duration mismatch can dampen or even reverse the transmission of unconventional monetary policy to bond yields and issuance.
Abstract: We develop a model that explains two stylized facts -- the coarseness of credit ratings relative to the underlying default probabilities, and the countercyclical nature of ratings precision. Ratings coarseness arises from the revenue-maximizing behavior of rating agencies, but it may also maximize net social surplus. There is scope for regulation since the private outcome may differ from the socially desirable outcome -- the planner puts a ceiling (floor) on the fee if the desired outcome is coarseness (precision). The analysis generates results consistent with existing empirical evidence as well as new predictions.
Discussant: Zhe Wang, Pennsylvania State University
Abstract: We study the relationship between bond ownership and demand for credit default swaps. We find that dispersion in bond holdings increases CDS issuance. We use an exogenous shock to the cost of CDS insurance and idiosyncratic differences in coordination costs across issuers, to document a causal link between bond ownership structure and the demand for protection. Our results are consistent with a renegotiation risk hypothesis: fragmented ownership increases coordination costs hampering bondholders' ability to renegotiate in distress thus increasing demand for external insurance. Our evidence has implications for the regulation of CDS markets and the design of bond securities.
Discussant: Stanislava Nikolova, University of Nebraska-Lincoln
