Mutual Fund Holdings of Credit Default Swaps: Liquidity, Yield, and Risk
60 Pages Posted: 16 Jan 2015 Last revised: 5 Aug 2020
Date Written: August 4, 2020
This study analyzes the motives for and consequences of funds’ credit default swap (CDS) investments using mutual funds’ quarterly holdings from pre- to post-financial crisis. Funds resort to CDS investment when facing unpredictable liquidity needs. Funds sell more in reference entities where CDS is liquid relative to the underlying bonds and buy more when the CDS-bond basis is more negative. To enhance yield, funds engage in negative basis trading and sell CDS with the highest spreads within rating categories, and with spreads higher than those of their bond portfolios. Funds with superior portfolio returns also demonstrate more skills in CDS trading.
Keywords: credit default spread (CDS), mutual funds, liquidity management, reach for yield, risk-taking
JEL Classification: G20, G23
Suggested Citation: Suggested Citation