Credit rating-based capital regulation induces financial institutions to take on additional systematic risk. In this paper, we uncover interconnected channels through which this systematic risk hoarding affects financial stability using a proprietary ECB bond holdings dataset. First, banks and insurance corporations effectively reduce their capital buffers by hoarding bonds with high systematic credit risk. Second, this hoarding increases the portfolio concentration of credit rating-constrained and unconstrained financial institutions. Third, in addition to the general tendency of regulated financial institutions to fire sale bonds after rating downgrades, we reveal even larger fire sales precisely when their regulatory advantages of reaching for systematic yield disappear. Using a shock in capital regulation, we establish this causal relationship between the severity of fire sales and the tendencies of regulatory-constrained financial institutions to seek bonds with high systematic credit risk. Such systematic risk hoarding reduces capital buffer by an additional 16% in economic downturns.

We document a significantly negative relationship between the volume of issued green bonds and the future carbon intensity of non-financial corporates; this relationship is limited to firms with higher financial constraints and higher credit risk. The findings suggest that green bonds can help firms finance carbon reductions, but they also indicate that a considerable fraction of green bond financing does not lead to measurable benefits for the environment.

Central banks have used asset purchase programs to keep markets operational in times of crisis. We model how central bank asset purchases alleviate dealers' balance-sheet constraints, preventing markets from becoming one sided, improving price efficiency and reducing dealer risk positions. Central banks can fully alleviate dealers' balance-sheet constraints by purchasing assets at their fair value; an action which maximizes welfare when dealers are competitive. However, when there is imperfect competition amongst dealers, a central bank which bears costs from intervening may only purchase assets at a discount. We offer additional analysis on the role of lending programs when dealers have leverage constraints, dealers who are unable to net out all balance sheet costs, and cross-asset impacts from interventions.

This paper investigates the impact of institutional herding on stock price formation, conditional on firms’ credit ratings, using 13F data from 1986 to 2019. In line with the current literature, we find herding intensity is driven by past returns consistent with momentum trading; however, we also find that herding is more sensitive to past returns for non-investment grade (NIG) stocks than investment grade (IG) stocks, resulting in a market bifurcation. We then examine the price impact of these trades and find that herding in NIG equities enhances price discovery. One plausible explanation is that information gradually diffuses within non-investment grade stocks, and herding behavior strengthens information discovery. Finally, we show both momentum-triggered herding and non-momentum-triggered herding contribute to price discovery among non-investment grade stocks.

Effective risk management in pension funds requires the use of appropriate long-term risk and performance indicators. However, Defined Contribution (DC) pension plans currently rely on short-term metrics that don't align with the retirement income goals of beneficiaries. Against this backdrop, we introduce a funding ratio measure for DC plans defined as the plan assets divided by accrued benefits derived from any given (defined) stream of contributions. The funding ratio's denominator is the present value of the total retirement income achievable if all contributions had been invested in fully amortizing fixed-income portfolios called retirement bonds. We also use the retirement bonds to introduce a class of target-income strategies that can effectively reduce income risk as retirement approaches, but also secure minimum funding ratio levels. These simple asset allocation rules strongly dominate the standard target-date fund strategies routinely used by DC plans, in terms of retirement outcomes for beneficiaries.