Swing Pricing for Mutual Funds: Breaking the Feedback Loop between Fire Sales and Fund Redemptions

47 Pages Posted: 10 Sep 2018 Last revised: 20 Nov 2019

See all articles by Agostino Capponi

Agostino Capponi

Columbia University

Paul Glasserman

Columbia Business School

Marko Weber

National University of Singapore (NUS) - Department of Mathematics

Date Written: March 16, 2019

Abstract

We develop a model of the feedback between mutual fund outflows and asset illiquidity. Following a market shock, alert investors anticipate the impact on a fund's net asset value (NAV) of other investors' redemptions and exit first at favorable prices. This first-mover advantage may lead to fund failure through a cycle of falling prices and increasing redemptions. Our analysis shows that (i) the first-mover advantage introduces a nonlinear dependence between a market shock and the aggregate impact of redemptions on the fund's NAV; (ii) as a consequence, there is a critical magnitude of the shock beyond which redemptions bring down the fund; (iii) properly designed swing pricing transfers liquidation costs from the fund to redeeming investors and, by removing the nonlinearity stemming from the first-mover advantage, it reduces these costs and prevents fund failure. Achieving these objectives requires a larger swing factor at larger levels of outflows. The swing factor for one fund may also depend on policies followed by other funds.

Keywords: mutual funds, first-mover advantage, swing price, fire sales, financial stability

JEL Classification: G01, G23, G28

Suggested Citation

Capponi, Agostino and Glasserman, Paul and Weber, Marko, Swing Pricing for Mutual Funds: Breaking the Feedback Loop between Fire Sales and Fund Redemptions (March 16, 2019). Office of Financial Research Research Paper No. 18-04, Columbia Business School Research Paper No. 18-72, Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3245963 or http://dx.doi.org/10.2139/ssrn.3245963

Agostino Capponi

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
United States

Paul Glasserman (Contact Author)

Columbia Business School ( email )

3022 Broadway
403 Uris Hall
New York, NY 10027
United States
212-854-4102 (Phone)
212-316-9180 (Fax)

Marko Weber

National University of Singapore (NUS) - Department of Mathematics ( email )

Department of Mathematics
Singapore, 117543
Singapore

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