42 Pages Posted: 9 Oct 2018
Date Written: September 17, 2018
We study the effect of strategic complementarities among investors on their decisions to continue to invest in a security issuer. Using detailed security level holdings of U.S. Money Market Mutual Funds (MMFs), we construct a novel measure of portfolio similarity among institutional investors (i.e. MMFs) who are exposed to the same security issuer. Consistent with correlated liquidity needs of more similar investors, the similarity of a fund to other investors in an issuer induces a correlation between the default states of the issuer and the states where the fund's liquidity demand is high. Among funds investing in the same issuer at the same time, we find that the funds reducing their exposure to the issuer are the most similar funds. At the issuer level, the average similarity of the funds investing in an issuer predicts the issuer's total funding flows in the next period. In other words, issuers cannot substitute this loss in funds from similar investors, particularly during crises, and are thus exposed to greater funding liquidity risk.
Keywords: institutional investors, liquidity risk, wholesale funding
JEL Classification: G1, G21
Suggested Citation: Suggested Citation