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

Abstract

This paper exploits hurricanes to show the link between nonfundamental shocks and real economic activities. Hurricanes create liquidity demand from investors living in disaster zones, which translates into $3.5 billion of outflows for mutual funds headquartered in the same areas. Such outflows cause fire sales, leading abnormal returns of firms unrelated to the hurricane to temporary drop by 10%. The nonfundamental shock induces firms to reduce investment and time the market by increasing share repurchases. These results indicate that when mutual funds outflows stem from liquidity needs unrelated to fund performance, the resulting nonfundamental price variations affect firms’ real decisions.

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

JEL Classification: G14, G31, G23, Q54.