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Does mutual fund illiquidity introduce fragility into asset prices? Evidence from the corporate bond market

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  • Jiang, Hao
  • Li, Yi
  • Sun, Zheng
  • Wang, Ashley

Abstract

Open-end corporate bond mutual funds invest in illiquid assets while providing liquid claims to shareholders. Does such liquidity transformation introduce fragility to the corporate bond market? To address this question, we create a novel bond-level latent fragility measure based on asset illiquidity of mutual funds holding the bond. We find that corporate bonds bearing higher fragility subsequently experience higher return volatility and more outflows-induced mutual fund selling over the period of 2006–2019. Using the COVID-19 crisis as a natural experiment, we find that bonds with higher precrisis fragility experienced more negative returns and larger reversals around March 2020.

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  • Jiang, Hao & Li, Yi & Sun, Zheng & Wang, Ashley, 2022. "Does mutual fund illiquidity introduce fragility into asset prices? Evidence from the corporate bond market," Journal of Financial Economics, Elsevier, vol. 143(1), pages 277-302.
    • Handle: RePEc:eee:jfinec:v:143:y:2022:i:1:p:277-302
    DOI: 10.1016/j.jfineco.2021.05.022
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    2. Cesa-Bianchi, Ambrogio & Eguren-Martin, Fernando, 2021. "Dash for dollars," Bank of England working papers 932, Bank of England.
    3. Dunne, Peter & Emter, Lorenz & Fecht, Falko & Giuliana, Raffaele & Peia, Oana, 2023. "Financial fragility in open-ended mutual funds: the role of liquidity management tools," ESRB Working Paper Series 140, European Systemic Risk Board.
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    6. Robert Czech, 2022. "Comment on "Open-ended bond funds: systemic risks and policy implications" by Stijn Claessens and Ulf Lewrick," Aussenwirtschaft, University of St. Gallen, School of Economics and Political Science, Swiss Institute for International Economics and Applied Economics Research, vol. 72(01), pages 63-66, December.
    7. Dekker, Lennart & Molestina Vivar, Luis & Wedow, Michael & Weistroffer, Christian, 2023. "Liquidity buffers and open-end investment funds: containing outflows and reducing fire sales," Working Paper Series 2825, European Central Bank.
    8. Milan Szabo, 2023. "Cyclical Investment Behavior of Investment Funds: Its Heterogeneity and Drivers," Working Papers 2023/5, Czech National Bank.
    9. Noam Ben-Ze'ev, 2023. "Drivers of Flows-Performance Sensitivity in Mutual Funds," Bank of Israel Working Papers 2023.06, Bank of Israel.

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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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