Gambling for market recovery? European insurers' corporate bond investments during market stress

Abstract Using daily stock market data for European insurers, I investigate how a stock market contraction, as experienced during the COVID‐19 pandemic, affects insurers' credit risk allocation of their corporate bond portfolio. I find that insurers shift their portfolio holdings pro‐cyclically towards lower credit risk assets in the first month of the market contraction. As the crisis progresses, I find evidence for counter‐cyclical, riskier investment behavior by European insurers, especially in high‐yield instruments, that can neither be explained by credit rating downgrades of held bonds nor by hedging with CDS derivatives. This counter‐cyclical investment behavior cannot be observed for US firms, which provides evidence for a difference in investment behavior between US and European insurers. The observed investment behavior of European insurers could be beneficial for systemic stability by attenuating price declines through insurance liquidity provision, but excessive risk‐taking by insurance companies over longer periods can also reinforce systemic stress.