Liquidity Transformation and Financial Stability: Evidence from the Cash Management of Open-End Italian Mutual Funds

49 Pages Posted: 8 May 2017

Date Written: May 3, 2017

Abstract

A key structural vulnerability of open-end mutual funds is the potential liquidity mismatch between assets and liabilities. In this paper we study the management of liquidity transformation by open-end mutual funds through cash holdings and its potential implications for financial stability. Using supervisory data on Italian equity funds, we show that the amount of cash holdings reduces the probability that funds experiencing significant outflows make forced sales of assets that can potentially dislocate market valuations from fundamentals. Moreover, our results indicate that funds engaging in forced sales hold statistically more cash at the end of a month of financial distress than funds in financial distress that do not engage in forced sales. This evidence is consistent with recent empirical findings showing that funds facing significant redemptions may exacerbate periods of market stress by hoarding cash.

Keywords: liquidity transformation, open-end mutual funds, financial stability

JEL Classification: G12, G23

Suggested Citation

Branzoli, Nicola and Guazzarotti, Giovanni, Liquidity Transformation and Financial Stability: Evidence from the Cash Management of Open-End Italian Mutual Funds (May 3, 2017). Bank of Italy Temi di Discussione (Working Paper) No. 1113. Available at SSRN: https://ssrn.com/abstract=2964822 or http://dx.doi.org/10.2139/ssrn.2964822

Nicola Branzoli (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Giovanni Guazzarotti

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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