Mutual funds that experience large outflows of funds must quickly reduce their asset holdings, which generates sales at significant “fire sale” prices. The authors document the process and show that mutual funds do not mitigate the costs of flowmotivated trading. Thus, liquidity providers earn abnormal returns and the predictability of forced flows provides an incentive to front run the mutual funds.

EQUITY INVESTMENTS Asset Fire Sales (and Purchases) in Equity Markets

Against the backdrop of COVID-19, we study how the interactions of mutual funds and dealers introduce fragility to the municipal bond market and carry lasting impacts. During the crisis, trading activities surge while dealers' liquidity provision plunges for mutual-fund-held bonds, leading to greater price depressions in these bonds. Importantly, the crisis reshapes the market's perceptions of mutual fund fragility risks. In the aftermath, yield spreads widen significantly more for bonds with greater mutual fund exposures. Such post-crisis pricing effects reflect dealers' continued reluctance to provide liquidity for mutual-fund-held bonds and they are stronger for bonds whose mutual fund holders are more susceptible to investor runs.

Mutual Fund Fragility, Dealer Liquidity Provisions, and the Pricing of Municipal Bonds

Abstract We identify fixed-income mutual funds as an important contributor to the unusually high selling pressure in liquid asset markets during the COVID-19 crisis. We show that mutual funds experienced pronounced investor outflows amplified by their liquidity transformation. In meeting redemptions, funds followed a pecking order by first selling their liquid assets, including Treasuries and high-quality corporate bonds, which generated the most concentrated selling pressure in these markets. Overall, the estimated price impact of mutual funds was sizable at a third of the increase in Treasury yields and a quarter of the increase in corporate bond yields during the COVID-19 crisis. 

https://academic.oup.com/ageing/article-pdf/51/3/afac030/43895469/afac030.pdf

OUP accepted manuscript

Arachidonic acid matters

The heft of non-bank financial intermediaries (NBFIs) in the financial system has grown significantly after the Great Financial Crisis of 2008. This paper reviews structural shifts in intermediation and how NBFIs have shaped the demand and supply of liquidity in financial markets. We then lay out a framework for the key channels of systemic-risk propagation in the presence of NBFIs, emphasising the central role of leverage fluctuations through changes in margins. The debt capacity of an investor is increasing in the debt capacity of other investors in the system, so that leverage enables greater leverage, and spikes in margins can lead to system-wide deleveraging. In our framework, deleveraging and `dash for cash' scenarios (as during the Covid-19 crisis) emerge as two sides of the same coin, rather than being two distinct channels of stress propagation. These findings have implications for the design of NBFI regulations and of central bank backstops.

Michael Paluszek

Papers

Does Mutual Fund Illiquidity Introduce Fragility into Asset Prices? Evidence from the Corporate Bond Market

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

Carotenoid-rich microalgae promote growth and health conditions of Artemia nauplii

Carotenoid-rich microalgae promote growth and health conditions of Artemia nauplii

Effects of 0.5B2O3–0.5CuO on the microwave dielectric properties of low-temperature sintered ZZNT ceramics