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Flight-to-Liquidity, Market Uncertainty, and the Actions of Mutual Fund Investors

47 Pages Posted: 16 Jul 2012 Last revised: 17 May 2017

Azi Ben-Rephael

Indiana University - Kelley School of Business - Department of Finance

Date Written: May 16, 2017

Abstract

We explore the trading decisions of equity mutual funds during ten periods of extreme market uncertainty. We find that mutual funds reduced their aggregate holdings of illiquid stocks. Exploring the drivers behind this result reveals that this is mainly driven by larger withdrawals from funds that hold less liquid stocks. We further find that the sell-off of illiquid stocks occurred only after initial deterioration in market conditions, consistent with retail investors’ response to bad performance. At a broader level, this shows that mutual funds consumed liquidity during periods where liquidity was most valuable. Moreover, the fact that fund managers traded in response to these withdrawals suggests a potentially magnifying channel for the drop in illiquid stock prices, also known as flight-to-liquidity.

Keywords: market uncertainty, financial crisis, liquidity, flight-to-liquidity, mutual funds, institutional investors, price pressure

JEL Classification: G01, G11, G12, G14, G20

Suggested Citation

Ben-Rephael, Azi, Flight-to-Liquidity, Market Uncertainty, and the Actions of Mutual Fund Investors (May 16, 2017). Available at SSRN: https://ssrn.com/abstract=2107424 or http://dx.doi.org/10.2139/ssrn.2107424

Azi Ben-Rephael (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

HOME PAGE: http://www.kelley.iu.edu/finance/

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