Dynamic Liquidity Preferences of Mutual Funds
University of Illinois at Urbana-Champaign - Department of Finance
AFA 2009 San Francisco Meetings Paper
EFA 2008 Athens Meetings Paper
Second Singapore International Conference on Finance 2008
This paper examines the relation between expected market volatility and the demand for liquidity in open-end mutual funds. Using a panel of actively managed U.S. mutual funds from 1990 to 2009, I find evidence that mutual fund managers hold more cash and tilt their holdings more heavily toward liquid stocks during periods when expected market volatility is high. Moreover, mutual fund managers increase their cash holdings and increase their portfolio liquidity through trades during periods when expected market volatility increases. Cross-sectional tests suggest that the dynamic preferences for liquidity are driven by concerns over investor withdrawals during volatile times. I further provide evidence that this type of dynamic behavior leads to higher fund returns.
Number of Pages in PDF File: 45
Keywords: Mutual funds, liquidity, expected volatility, performance, market timing
JEL Classification: G11, G20, G30
Date posted: March 19, 2008 ; Last revised: February 18, 2014
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