Mutual Fund Liquidity Transformation and Reverse Flight to Liquidity
60 Pages Posted: 2 Jul 2020 Last revised: 9 Dec 2020
Date Written: July 29, 2020
We identify fixed-income mutual funds as an important contributor to the unusually high selling pressure in traditionally liquid asset markets during the Covid-19 crisis. We show that mutual fund liquidity transformation leads to pronounced investor outflows. In meeting redemptions, funds followed a pecking order by first selling their more liquid assets, which generated the most concentrated selling pressure in traditionally more liquid asset markets. Investors' flight to liquidity was thereby turned into an aggregate reverse flight to liquidity. The Fed's announced purchase of illiquid securities may be an effective policy tool for stabilizing liquidity transformation and liquid asset markets.
Keywords: Mutual fund, liquidity transformation, flight-to-liquidity, COVID-19
JEL Classification: G23, G28, G11
Suggested Citation: Suggested Citation