Mutual Fund Holdings of Credit Default Swaps: Liquidity, Yield, and Risk
80 Pages Posted: 16 Jan 2015 Last revised: 19 Dec 2019
Date Written: November 26, 2019
This study analyzes the motives for and consequences of funds’ CDS investments using mutual funds’ quarterly holdings of credit default swap (CDS) contracts from pre- to post-financial crisis periods. Funds resort to CDS investment when they face unpredictable liquidity needs. Funds sell more CDS in reference entities where CDS is liquid relative to the underlying bonds and buy more CDS when the CDS-bond basis is more negative. Funds’ CDS investment does not lead to superior risk-adjusted returns but enhances yield, by engaging in negative basis trading and selling CDS securities with credit spreads higher than those of their bond portfolios.
Keywords: credit default spread (CDS), mutual funds, liquidity management, reach for yield, risk-taking
JEL Classification: G20, G23
Suggested Citation: Suggested Citation