The Role of Institutional Investors in Propagating the Crisis of 2007-2008

Abstract

Using novel data on investors’ bond portfolios, we study the contagion of the crisis from securitized bonds to corporate bonds. When securitized bonds became “toxic” in August 2007, mutual funds retained the now illiquid securitized bonds and sold corporate bonds. Funds with negative flows or high liquidity needs liquidated more than others. Yield spreads increased more for corporate bonds whose pre-crisis bondholders were more heavily exposed to securitized bonds, compared to same-issuer bonds held by unexposed investors. The findings suggest that liquidity-constrained investors with exposure to securitized bonds played a role in propagating the crisis from securitized to corporate bonds.

Keywords: crisis transmission, securitized bonds, corporate bonds, liquidity channel

JEL Classification: G1, G2, G11, G12, G21, G22, G23