Bond Funds and Credit Risk

58 Pages Posted: 25 Nov 2019

See all articles by Jaewon Choi

Jaewon Choi

University of Illinois at Urbana-Champaign - Department of Finance

Amil Dasgupta

London School of Economics (LSE); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Ji Yeol Jimmy Oh

Hanyang University

Multiple version iconThere are 2 versions of this paper

Date Written: November 15, 2019

Abstract

We show that supply side effects arising from the bond holdings of open-end mutual funds affect corporate credit risk through a refinancing channel. In our framework, bond funds exposed to flow-performance relationships become excessively reluctant to refinance bonds of companies with poor cash flow prospects.

This lowers refinancing prices, enhancing incentives for strategic default, thus engendering a positive association between bond funds’ presence and credit risk. Empirically, we find that firms with a large share of mutual fund holdings experience increases in CDS spreads, particularly for funds that are more sensitive to flows. We address potential endogeneity issues by using fund acquisitions as exogenous shocks to funds’ flow concerns.

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 (November 15, 2019). 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 )

1206 South Sixth Street
Champaign, IL 61820
United States

Amil Dasgupta (Contact Author)

London School of Economics (LSE) ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 7458 (Phone)
+44 20 7955 7420 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Ji Yeol Jimmy Oh

Hanyang University ( email )

School of Business #513
Wangsimni-ro 222, Seongdong-gu
Seoul, Seoul 04763
Korea, Republic of (South Korea)
+82222202689 (Phone)

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