Mutual Fund Holdings of Credit Default Swaps: Liquidity, Yield, and Risk Taking
68 Pages Posted: 16 Jan 2015 Last revised: 7 Sep 2016
Date Written: September 1, 2016
Using mutual funds quarterly holdings of credit default swap (CDS) contracts from pre- to post-financial crisis, we analyze the motives for and consequences of funds' CDS investment. Funds resort to CDS selling when facing unpredictable liquidity needs and when the CDS security is liquid relative to the underlying bond, and to CDS buying as part of a "negative basis trade" when the bond is illiquid. Funds CDS strategies tilt toward yield enhancement, and smaller funds follow leading funds in risk taking. The reference entities that attracted the highest selling interest from the large funds were disproportionately large financial institutions.
Keywords: CDS, Mutual Funds, liquidity, systemic risk
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