Does Mutual Fund Illiquidity Introduce Fragility into Asset Prices? Evidence from the Corporate Bond Market

49 Pages Posted: 31 Dec 2019 Last revised: 2 Jul 2020

See all articles by Hao Jiang

Hao Jiang

Michigan State University

Yi Li

Federal Reserve Board

Zheng Sun

University of California, Irvine - Paul Merage School of Business

Ashley Wang

Federal Reserve Board

Date Written: June 30, 2020

Abstract

Open-end mutual funds have grown to become a key player in the corporate bond market. They invest in illiquid bonds but provide liquid claims to shareholders. Does such liquidity transformation introduce fragility to the corporate bond market? To address this question, we create a novel measure of latent fragility in individual corporate bonds based on the asset illiquidity of their mutual fund owners. We find that corporate bonds with higher fragility tend to experience higher future return volatility, after controlling for a rich set of bond characteristics such as credit rating, maturity, and bond illiquidity. Moreover, these bonds tend to have more outflows-induced mutual fund selling in the subsequent period. Using the Covid-19 pandemic as a natural experiment, we find that corporate bonds with higher latent fragility at the end of 2019 experienced more negative returns and larger increases in yields in March 2020.

Keywords: Corporate Bond Mutual Fund, Fragility, Volatility, Liquidity, Fire Sales

JEL Classification: G10, G12, G20, G23

Suggested Citation

Jiang, Hao and Li, Yi and Sun, Zheng and Wang, Ashley, Does Mutual Fund Illiquidity Introduce Fragility into Asset Prices? Evidence from the Corporate Bond Market (June 30, 2020). Available at SSRN: https://ssrn.com/abstract=3501969 or http://dx.doi.org/10.2139/ssrn.3501969

Hao Jiang

Michigan State University ( email )

315 Eppley Center
Department of Finance
East Lansing, MI 48824
United States

HOME PAGE: http://sites.google.com/site/haojiangfinance/

Yi Li (Contact Author)

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-721-4576 (Phone)

HOME PAGE: http://sites.google.com/view/yili/

Zheng Sun

University of California, Irvine - Paul Merage School of Business ( email )

Paul Merage School of Business
Irvine, CA California 92697-3125
United States

Ashley Wang

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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