A Dynamic Theory of Mutual Fund Runs and Liquidity Management
75 Pages Posted: 31 Jan 2017 Last revised: 25 Mar 2017
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A Dynamic Theory of Mutual Fund Runs and Liquidity Management
A Dynamic Theory of Mutual Fund Runs and Liquidity Management
Date Written: January 16, 2017
Abstract
I model an open-end mutual fund investing in illiquid assets and show that the fund’s endogenous cash management can generate shareholder runs even with a flexible NAV. The fund optimally re-builds its cash buffers at time t 1 after outflows at t to prevent future forced sales of illiquid assets. However, cash rebuilding at t 1 implies predictable voluntary sales of illiquid assets and hence a predictable decline in NAV. This generates a first-mover advantage, leading to runs. A time-inconsistency problem aggravates runs: the fund may want to pre-commit not to re-build cash buffers but cannot credibly do so absent a commitment device.
Keywords: open-end mutual fund, illiquid assets, shareholder runs, cash rebuilding, flexible NAV
JEL Classification: G01, G21, G23, G32, G33, D92
Suggested Citation: Suggested Citation