Passive-Aggressive Trading: The Supply and Demand of Liquidity by Mutual Funds
40 Pages Posted: 10 Mar 2018
Date Written: March 9, 2018
Fund managers can demand liquidity for their trading ideas or provide liquidity for others’ ideas. We identify the roles of these motives using a database of the individual transactions by Canadian equity funds. Both the cost and subsequent performance of their buys decline after strong inflows, indicating the depletion of ideas and substitution into liquidity provision as funds put new money to work. Sales show little of this substitution, consistent with funds’ narrower latitude to provide liquidity to buyers. In general, the option to provide liquidity makes fund returns positive in the transactions costs of buys, but not of sells.
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