Assessing Credit Risk in Money Market Funds During the Eurozone Crisis

44 Pages Posted: 20 May 2014 Last revised: 26 Jun 2016

See all articles by Sean Collins

Sean Collins

Investment Company Institute - Research

Emily Gallagher

University of Colorado at Boulder - Department of Finance; Federal Reserve Banks - Federal Reserve Bank of St. Louis

Date Written: August 14, 2015

Abstract

This paper measures credit risk in prime money market funds (MMFs) and studies how such credit risk evolved during the eurozone crisis of 2011-2012. To accomplish this, we estimate the annualized expected loss on each fund’s portfolio. We also calculate by Monte Carlo the cost of insuring a fund against losses amounting to over 50 basis points. We find that credit risk of prime MMFs, though small, doubled from 12 basis points in June 2011 to 23 basis points in December 2011 before receding in 2012. Contrary to common perceptions, this did not primarily reflect funds’ credit exposure to eurozone banks because funds took measures to reduce this exposure. Instead, credit risk in prime MMFs rose because of the deteriorating credit outlook of banks in the Asia/Pacific region. We conclude that the increase in the credit risk of prime MMFs in the second half of 2011 reflected contagion in the worldwide banking system coupled with slowing global economic growth, not actions taken by MMFs.

Keywords: Money market mutual funds; credit risk; copula; default probability; break the buck

JEL Classification: G01, G18, G23, G28

Suggested Citation

Collins, Sean S. and Gallagher, Emily, Assessing Credit Risk in Money Market Funds During the Eurozone Crisis (August 14, 2015). Journal of Financial Stability, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2438908 or http://dx.doi.org/10.2139/ssrn.2438908

Sean S. Collins

Investment Company Institute - Research ( email )

202-326-5882 (Phone)

Emily Gallagher (Contact Author)

University of Colorado at Boulder - Department of Finance ( email )

Campus Box 419
Boulder, CO 80309
United States

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

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