Mutual Funds' Fire Sales and the Real Economy: Evidence from Hurricanes

Abstract

This paper proposes a novel empirical design to identify non-fundamental shocks to asset prices and studies how they can affect real economic activities. I exploit hurricanes that hit the headquarters of mutual funds and cause exogenous outflows. These outflows force mutual funds to sell their geographically distant holdings at fire-sale prices, leading to a temporary drop in abnormal returns for firms unrelated to the hurricane. I show that this non-fundamental price variation induces firms to reduce their investment. The effect on investment is permanent, not driven by financing constraints and explained by managerial market timing. These results indicate that when mutual funds outflows are unrelated to firms fundamentals, the resulting non-fundamental price variations affect firms’ real decisions.

Keywords: real effects, corporate investments, natural disasters, fire sales.

JEL Classification: G14, G31, G23, Q54.