Toggle Mobile Menu
Academic Programs

I document an important shift in the comovement between the 10-year Treasury yield and corporate bond credit spreads. Before the Great Financial Crisis, there was no apparent correlation between the long-term rate and bond credit spreads. However, after the Great Financial Crisis, corporate bond credit spreads tend to be high when the 10-year Treasury yield is low, and the effect is more substantial for lower credit ratings. Next, I demonstrate that this new comovement is tightly linked to life insurance companies’ bond holdings and duration mismatch. Following increases in the 10-year yield, the credit spreads on bonds with greater insurer ownership drop more. This relationship was absent before the great financial crisis when life insurers were hedged against interest rate risk and became pronounced after the great financial crisis when life insurers faced severe duration mismatch. I then propose an intermediary asset pricing model with duration mismatch to explain these findings. In this model, life insurers’ liabilities have a longer duration than their assets. Therefore, when the 10-year yield declines, insurers incur equity loss and higher leverage. As a result, their effective risk aversion rises, leading to higher equilibrium credit spreads. The model has important implications for policies that target the long-term interest rate.