ABSTRACT

Post-2008, corporate bond credit spreads decline when long-term interest rates increase. The pattern holds both unconditionally and around monetary policy announcements. In the cross-section, this negative co-movement is more pronounced for bonds held by life insurers. To rationalize these findings, I propose a model where life insurers with long-duration liabilities face duration mismatch and realize equity gains when long rates increase. The equity gains boost insurers’ risk-bearing capacity and drive down equilibrium credit spreads. The model quantitatively explains the empirical finding and shows that insurers’ duration mismatch can dampen or reverse unconventional monetary policy transmission to bond yields and issuance.