Mutual Fund Liquidity Transformation and Reverse Flight to Liquidity

60 Pages Posted: 2 Jul 2020 Last revised: 19 Feb 2021

See all articles by Yiming Ma

Yiming Ma

Columbia University - Columbia Business School

Kairong Xiao

Columbia University - Columbia Business School

Yao Zeng

University of Pennsylvania - The Wharton School

Date Written: July 29, 2020

Abstract

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

Ma, Yiming and Xiao, Kairong and Zeng, Yao, Mutual Fund Liquidity Transformation and Reverse Flight to Liquidity (July 29, 2020). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=3640861 or http://dx.doi.org/10.2139/ssrn.3640861

Yiming Ma

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Kairong Xiao (Contact Author)

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Yao Zeng

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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