Mutual Fund Holdings of Credit Default Swaps: Liquidity, Yield, and Risk

This study analyzes the motives for and consequences of funds’ credit default swap (CDS) investments using mutual funds’ quarterly holdings from pre- to post-financial crisis. Funds resort to CDS investment when facing unpredictable liquidity needs. Funds sell more in reference entities where CDS is liquid relative to the underlying bonds and buy more when the CDS-bond basis is more negative. To enhance yield, funds engage in negative basis trading and sell CDS with the highest spreads within rating categories, and with spreads higher than those of their bond portfolios. Funds with superior portfolio returns also demonstrate more skills in CDS trading.

Keywords: credit default spread (CDS), mutual funds, liquidity management, reach for yield, risk-taking

JEL Classification: G20, G23

Suggested Citation: Suggested Citation

Jiang, Wei and Ou, Jitao and Chu, John Chung-Yen, Mutual Fund Holdings of Credit Default Swaps: Liquidity, Yield, and Risk (August 4, 2020). Journal of Finance Forthcoming, Columbia Business School Research Paper No. 15-9, Available at SSRN: https://ssrn.com/abstract=2549996 or http://dx.doi.org/10.2139/ssrn.2549996