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Do fire sales create externalities?

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  • Chernenko, Sergey
  • Sunderam, Adi

Abstract

We develop three novel measures of the incentives of equity mutual funds to internalize the price impact of their trading. We show that mutual funds with stronger incentives to internalize their price impact accommodate inflows and outflows by adjusting their cash buffers instead of trading in portfolio securities. As a result, stocks held by these funds have lower volatility, and flows out of these funds have smaller spillover effects on other funds holding the same securities. Our results provide evidence of meaningful fire sale externalities in the equity mutual fund industry.

Suggested Citation

  • Chernenko, Sergey & Sunderam, Adi, 2020. "Do fire sales create externalities?," Journal of Financial Economics, Elsevier, vol. 135(3), pages 602-628.
  • Handle: RePEc:eee:jfinec:v:135:y:2020:i:3:p:602-628
    DOI: 10.1016/j.jfineco.2019.08.001
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    Cited by:

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    2. Irani, Rustom & Iyer, Rajkamal & Meisenzahl, Ralf & Peydró, José-Luis, 2021. "The rise of shadow banking: Evidence from capital regulation," EconStor Open Access Articles and Book Chapters, ZBW - Leibniz Information Centre for Economics, pages 2181-2235.
    3. Fricke, Daniel & Wilke, Hannes, 2020. "Connected Funds," VfS Annual Conference 2020 (Virtual Conference): Gender Economics 224511, Verein für Socialpolitik / German Economic Association.
    4. Cutura, Jannic & Parise, Gianpaolo & Schrimpf, Andreas, 2020. "Debt De-risking," CEPR Discussion Papers 14817, C.E.P.R. Discussion Papers.
    5. Sergey Chernenko & Adi Sunderam, 2020. "Measuring the Perceived Liquidity of the Corporate Bond Market," NBER Working Papers 27092, National Bureau of Economic Research, Inc.
    6. Lyócsa, Štefan & Baumöhl, Eduard & Vŷrost, Tomáš, 2021. "YOLO trading: Riding with the herd during the GameStop episode," EconStor Preprints 230679, ZBW - Leibniz Information Centre for Economics.
    7. Christian Kubitza, 2021. "Tackling the Volatility Paradox: Spillover Persistence and Systemic Risk," ECONtribute Discussion Papers Series 079, University of Bonn and University of Cologne, Germany.
    8. Thierry Roncalli, 2021. "Liquidity Stress Testing in Asset Management -- Part 3. Managing the Asset-Liability Liquidity Risk," Papers 2110.01302, arXiv.org.

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    More about this item

    Keywords

    Fire sales; Liquidity management; Mutual funds;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other

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