Do Mutual Funds and ETFs Affect the Commonality in Liquidity of Corporate Bonds?

58 Pages Posted: 18 Sep 2020 Last revised: 6 Dec 2021

See all articles by Efe Cotelioglu

Efe Cotelioglu

American University of Sharjah

Date Written: November 29, 2019

Abstract

The paper studies the effect of growing mutual fund and ETF ownership on the commonality in liquidity of underlying bonds. Unpredictable liquidity needs of funds may give rise to correlated trading across underlying illiquid bonds. I document that there is a positive and significant relationship between ETF ownership and liquidity commonality of investment-grade bonds suggesting that ETFs reduce the possibility to diversify liquidity risk. In contrast, and unlike for equities, mutual fund ownership does not affect the co-movement in liquidity of bonds. I show that three channels explain the differential impact of ETFs and mutual funds: flow-driven correlated trading, different investor clienteles, and ETF arbitrage activity.

Keywords: Corporate Bonds, Liquidity, Commonality, Arbitrage, Exchange-Traded Funds (ETFs), Mutual Funds

JEL Classification: G12, G14, G20

Suggested Citation

Cotelioglu, Efe, Do Mutual Funds and ETFs Affect the Commonality in Liquidity of Corporate Bonds? (November 29, 2019). Swiss Finance Institute Research Paper No. 20-81, Available at SSRN: https://ssrn.com/abstract=3495716 or http://dx.doi.org/10.2139/ssrn.3495716

Efe Cotelioglu (Contact Author)

American University of Sharjah ( email )

P.O. Box 26666
Sharjah
United Arab Emirates

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