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  • 2020
  • Working Paper

Internal Models, Make Believe Prices, and Bond Market Cornering

By: Ishita Sen and Varun Sharma
  • Format:Print
  • | Language:English
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Abstract

Exploiting position-level heterogeneity in regulatory incentives to misreport and novel data on regulators, we document that U.S. life insurers inflate the values of corporate bonds using internal models. We estimate an additional $9-$18 billion decline in regulatory capital during the 2008 crisis, i.e., a 30% greater decline than what was reported. Supervision helps dissuade misreporting, but only when close pricing benchmarks exist. Insurers, in response, strategically shift asset selection toward bonds where price verification is harder, and corner small bonds. Our findings have consequences for assessing the fragility of financial institutions and for understanding the price discovery of corporate bonds.

Keywords

Life Insurers; Capital Regulation; Internal Models; Corporate Bonds; Regulatory Supervision; Concentrated Ownership; Bonds; Capital; Governing Rules, Regulations, and Reforms; Insurance; Investment Portfolio

Citation

Sen, Ishita, and Varun Sharma. "Internal Models, Make Believe Prices, and Bond Market Cornering." Working Paper, June 2020.
  • SSRN

About The Author

Ishita Sen

Finance
→More Publications

More from the Authors

    • November 2022 (Revised May 2023)
    • Faculty Research

    Dicerna

    By: Malcolm Baker, Ishita Sen and Jonathan Wallen
    • 2021
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    Pricing of Climate Risk Insurance: Regulation and Cross-Subsidies

    By: Ishita Sen, Ana-Maria Tenekedjieva and Sangmin Oh
    • April 2021 (Revised April 2022)
    • Faculty Research

    Next Insurance: Considering New Markets

    By: David S. Scharfstein, Ishita Sen and Dean Xu
More from the Authors
  • Dicerna By: Malcolm Baker, Ishita Sen and Jonathan Wallen
  • Pricing of Climate Risk Insurance: Regulation and Cross-Subsidies By: Ishita Sen, Ana-Maria Tenekedjieva and Sangmin Oh
  • Next Insurance: Considering New Markets By: David S. Scharfstein, Ishita Sen and Dean Xu
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