54 Pages Posted: 12 Jun 2020 Last revised: 5 Mar 2021
Date Written: May 19, 2020
We examine the incentive of corporate bond fund managers to manipulate portfolio risk in response to competitive pressure. We find that bond funds engage in a reverse tournament in which laggard funds actively de-risk their portfolios, trading off yield for liquidity. Precautionary de-risking is reinforced by a more concave flow-to-performance sensitivity and by periods of market stress, whereas it is weakened by low interest rates. We provide evidence that de-risking is effective in reducing ex post liquidation costs by mitigating the feedback loop between bond and fund liquidity. Flexible NAVs (swing pricing) may, however, dissuade de-risking and reintroduce moral hazard.
Keywords: Bond mutual funds, liquidity, tournaments, risk, swing pricing
JEL Classification: G11, G23, G32, E43
Suggested Citation: Suggested Citation