Do Buy-Side Institutions Supply Liquidity in Bond Markets? Evidence from Mutual Funds
65 Pages Posted: 19 Jul 2017 Last revised: 13 Jul 2018
Date Written: July 11, 2018
We examine the role of buy-side institutions as liquidity suppliers in bond markets. Focusing on mutual funds, we classify a fund’s trading style as liquidity supplying (demanding) if the fund helps absorb (strain) dealers’ inventory. While mutual funds in aggregate demand liquidity, persistent cross-sectional variation exists – stable funding, family affiliation with dealers, and fund manager skill are associated with liquidity supply. Liquidity supplying trading style earns higher alpha, especially in illiquid markets. Our evidence suggests that bond market liquidity can be enhanced by removing institutional frictions that impede broad investor participation in liquidity provision.
Keywords: Bond liquidity; buy-side institutions; dealer inventory; mutual funds; fund performance.
JEL Classification: G10; G20
Suggested Citation: Suggested Citation