Does Mutual Fund Illiquidity Introduce Fragility into Asset Prices? Evidence from the Corporate Bond Market
73 Pages Posted: 31 Dec 2019 Last revised: 3 Feb 2021
Date Written: December 23, 2020
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 pre-crisis fragility experienced more negative returns and larger reversals around March 2020.
Keywords: Corporate bond mutual fund, liquidity transformation, fragility, volatility
JEL Classification: G10, G12, G20, G23
Suggested Citation: Suggested Citation