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The cross section of money market fund risks and financial crises

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  • Patrick E. McCabe
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    Abstract

    This paper examines the relationship between money market fund (MMF) risks and outcomes during crises, with a focus on the ABCP crisis in 2007 and the run on money funds in 2008. I analyze three broad types of MMF risks: portfolio risks arising from a fund's assets, investor risk reflecting the likelihood that a fund's shareholders will redeem shares disruptively, and sponsor risk due to uncertainty about MMF sponsors' support for distressed funds. I find that during the run on MMFs in September and October 2008, outflows were larger for MMFs that had previously exhibited greater degrees of all three types of risk. In contrast, as the asset-backed commercial paper (ABCP) crisis unfolded in 2007, many MMFs suffered capital losses, but investor flows were relatively unresponsive to risks, probably because investors correctly believed that sponsors would absorb the losses. However, the consequences of MMF risks were quite costly for some sponsors: Using a unique data set of sponsor interventions, I show that sponsor financial support was more likely for MMFs that previously earned higher gross yields (a measure of portfolio risk) and funds with bank-affiliated sponsors. Funds' gross yields and bank affiliation (but not funds' ratings) also would have helped forecast holdings of distressed ABCP. This paper provides some useful lessons for investors and policymakers. The significance of MMF risks in predicting poor outcomes in past crises highlights the importance of monitoring such risks, and I offer some useful proxies for doing so. The paper also argues for greater attention to the systemic risks posed by the industry's reliance on discretionary sponsor support.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2010-51.

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    Date of creation: 2010
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    Handle: RePEc:fip:fedgfe:2010-51

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    Keywords: Money market funds ; Mutual funds ; Asset-backed financing;

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    References

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    1. Naohiko Baba & Robert N McCauley & Srichander Ramaswamy, 2009. "US dollar money market funds and non-US banks," BIS Quarterly Review, Bank for International Settlements, March.
    2. Chevalier, J. & Ellison, G., 1996. "Risk Taking by Mutual Funds as a Response to Incentives," Working papers 96-3, Massachusetts Institute of Technology (MIT), Department of Economics.
    3. Guercio, Diane Del & Tkac, Paula A., 2002. "The Determinants of the Flow of Funds of Managed Portfolios: Mutual Funds vs. Pension Funds," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(04), pages 523-557, December.
    4. Burcu Duygan-Bump & Patrick Parkinson & Eric Rosengren & Gustavo A. Suarez & Paul Willen, 2013. "How Effective Were the Federal Reserve Emergency Liquidity Facilities? Evidence from the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility," Journal of Finance, American Finance Association, vol. 68(2), pages 715-737, 04.
    5. Lyon, Andrew B, 1984. " Money Market Funds and Shareholder Dilution," Journal of Finance, American Finance Association, vol. 39(4), pages 1011-20, September.
    6. Jank, Stephan & Wedow, Michael, 2008. "Sturm und Drang in money market funds: when money market funds cease to be narrow," Discussion Paper Series 2: Banking and Financial Studies 2008,20, Deutsche Bundesbank, Research Centre.
    7. Pennacchi, George, 2006. "Deposit insurance, bank regulation, and financial system risks," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 1-30, January.
    8. Ali Hortacsu & Chad Syverson, 2003. "Product Differentiation, Search Costs, and Competition in the Mutual Fund Industry: A Case Study of the S&P 500 Index Funds," NBER Working Papers 9728, National Bureau of Economic Research, Inc.
    9. Susan E. K. Christoffersen, 2001. "Why Do Money Fund Managers Voluntarily Waive Their Fees?," Journal of Finance, American Finance Association, vol. 56(3), pages 1117-1140, 06.
    10. DeGennaro, Ramon P & Domian, Dale L, 1996. "Market Efficiency and Money Market Fund Portfolio Managers: Beliefs versus Reality," The Financial Review, Eastern Finance Association, vol. 31(2), pages 453-74, May.
    11. Daniel M. Covitz & Nellie Liang & Gustavo A. Suarez, 2009. "The evolution of a financial crisis: panic in the asset-backed commercial paper market," Finance and Economics Discussion Series 2009-36, Board of Governors of the Federal Reserve System (U.S.).
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    Cited by:
    1. Tobias Adrian & Daniel Covitz & Nellie Liang, 2013. "Financial stability monitoring," Finance and Economics Discussion Series 2013-21, Board of Governors of the Federal Reserve System (U.S.).
    2. Gary Gorton & Andrew Metrick, 2012. "Entérese rápidamente de la crisis financiera: guía de lectura para un fin de semana," Revista de Economía Institucional, Universidad Externado de Colombia - Facultad de Economía, vol. 14(26), pages 15-46, January-J.

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