The Role of Equity Funds in the Financial Crisis Propagation

Abstract

The early stage of the 2007-08 financial crisis was marked by large value losses for bank stocks. This paper identifies the equity funds most affected by this valuation shock and examines its consequences for the nonfinancial stocks owned by the respective funds. We document three key empirical findings. First, ownership links to these distressed equity funds lead to large temporary underperformance of the most exposed nonfinancial stocks. Second, distressed equity funds make the better performing stocks in their portfolio the preferred liquidation choice, which implies clustering of fire sale discounts among stocks in the high return quantiles. Third, stocks with higher overall fund ownership generally performed better throughout the crisis.

Keywords: Financial Crisis, Crisis Spillover Effect, Mutual Fund Ownership

JEL Classification: G11, G14, G23