Bond Funds and Credit Risk

73 Pages Posted: 25 Nov 2019 Last revised: 15 Sep 2020

See all articles by Jaewon Choi

Jaewon Choi

University of Illinois at Urbana-Champaign - Department of Finance

Amil Dasgupta

London School of Economics (LSE); European Corporate Governance Institute (ECGI)

Ji Yeol Jimmy Oh

Hanyang University

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2020

Abstract

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 refinance bonds of companies with poor cash flow prospects fearing future investor outflows as a result of potential default events. This lowers refinancing prices, enhancing incentives for strategic default by equityholders, engendering a positive association between bond funds’ presence and credit risk. Empirically, we find that in firms with poor cash flow prospects, active fund bond holdings are associated with increased CDS spreads, more so when funds are more sensitive to flows. We use an instrumental variable approach and a quasi-experiment based on the departure of Bill Gross from PIMCO to address the endogeneity between fund holdings and credit spreads.

Keywords: fund flows, flow fragility, career concerns, bond rollover, default-liquidity loop

JEL Classification: G23, G32

Suggested Citation

Choi, Jaewon and Dasgupta, Amil and Oh, Ji Yeol Jimmy, Bond Funds and Credit Risk (September 1, 2020). European Corporate Governance Institute – Finance Working Paper No. 639/2019, Available at SSRN: https://ssrn.com/abstract=3490683 or http://dx.doi.org/10.2139/ssrn.3490683

Jaewon Choi

University of Illinois at Urbana-Champaign - Department of Finance ( email )

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Amil Dasgupta (Contact Author)

London School of Economics (LSE) ( email )

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European Corporate Governance Institute (ECGI) ( email )

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Ji Yeol Jimmy Oh

Hanyang University ( email )

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Seoul, Seoul 04763
Korea, Republic of (South Korea)
+82222202689 (Phone)

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