Mutual Fund Flight-to-Liquidity
55 Pages Posted: 7 Feb 2017 Last revised: 9 Dec 2020
Date Written: October 5, 2017
This paper empirically investigates a demand-side channel through which market uncertainty affects the liquidity premium. Using data at the mutual fund level, I document that fund managers actively shift the composition of their portfolio toward more liquid assets during high volatility periods. I argue that the increased demand for liquidity in times of market stress stems from a threat of strategic complementarities among investors. Aggregated over many funds, this `flight-to-liquidity' places a significant upward price pressure on the liquidity premium: a one standard deviation increase in my measure of active liquidity management yields 4.004pp increase in annualized reversal strategy return.
Keywords: Market uncertainty, financial crisis, liquidity, flight-to-liquidity, mutual funds, institutional investors, price pressure, systematic risk, strategic complementarities
JEL Classification: G01, G11, G23
Suggested Citation: Suggested Citation