Bond Funds and Credit Risk
81 Pages Posted: 25 Nov 2019 Last revised: 31 Mar 2022
Date Written: March 28, 2022
We show that supply-side effects arising from the bond holdings of open-end mutual funds affect corporate credit risk. In our model, funds exposed to flow-performance relationships are reluctant to roll over bonds of companies with weak cash flow prospects fearing future outflows. This lowers rollover prices, enhancing equityholders’ strategic default incentives, engendering a positive association between bond funds’ presence and credit risk. Empirically, we find that in firms with weak cash flow prospects, fund holding shares increase CDS spreads, and more so when flows are more sensitive to performance. We use instrumental variables and quasi-experiments to address endogeneity concerns.
Keywords: Fund flows, credit risk, flow concerns, bond rollover, default-liquidity loop
JEL Classification: G23, G32
Suggested Citation: Suggested Citation