Fire-Sale Spillovers in Debt Markets

60 Pages Posted: 21 Dec 2016 Last revised: 11 Jan 2017

See all articles by Antonio Falato

Antonio Falato

Board of Governors of the Federal Reserve System

Ali Hortacsu

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Dan Li

Federal Reserve Board

Chaehee Shin

Board of Governors of the Federal Reserve System

Date Written: December 20, 2016

Abstract

We assess fire-sale spillovers empirically using a new approach to measure network linkages across financial institutions and rich micro data for the universe of open-end fixed-income mutual funds. We find evidence that flows are interdependent across funds with asset class overlap, consistent with the hypothesis that one fund's redemptions may spill-over on to those of other funds by leading to distressed sales that adversely impact other funds' performance. We use several strategies to identify the causal link between any given fund's flows and those of its peers, including a regression discontinuity (RD) design that exploits sharp changes in peer flows around Morningstar 5-star ratings. The source of identification of our RD approach is quasi-random variation in peer flows around the arbitrary performance cutoffs used by Morningstar to assign their 5-star ratings, which is plausibly unrelated to changes in common industry fundamentals. Consistent with a fire-sale mechanism, not just fund flows, but also fund performance and liquidity, as well as the pricing of corporate bonds sold by funds under peer pressure, are adversely affected. Our approach yields simple measures of vulnerability of a fund family to system-wide flow pressures, which can be used for policy evaluation of alternative financial stability tools.

Keywords: asset management, fixed-income markets, fire-sales, identification of spillover effects

JEL Classification: G00, G20

Suggested Citation

Falato, Antonio and Hortacsu, Ali and Li, Dan and Shin, Chaehee, Fire-Sale Spillovers in Debt Markets (December 20, 2016). Fourth Annual Conference on Financial Market Regulation. Available at SSRN: https://ssrn.com/abstract=2887822 or http://dx.doi.org/10.2139/ssrn.2887822

Antonio Falato (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Ali Hortacsu

University of Chicago - Department of Economics ( email )

1126 East 59th Street
Chicago, IL 60637
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773-702-5841 (Phone)

National Bureau of Economic Research (NBER)

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Dan Li

Federal Reserve Board ( email )

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Mail Stop 89
Washington, DC 20551
United States

Chaehee Shin

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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