Mutual Fund Fragility, Dealer Liquidity Provisions, and the Pricing of Municipal Bonds
51 Pages Posted: 13 Nov 2020 Last revised: 10 May 2021
Date Written: November 11, 2020
We study the Covid-19 financial crisis to examine the role dealers play in transmitting potential fragility risks posed by mutual funds to the municipal bond market. Following unprecedented outflows from muni mutual funds, we show that bonds held by these funds trade substantially more and suffer greater price depressions than bonds not in muni funds. Dealer liquidity provision declines more in these bonds, exacerbating their market conditions. In the crisis aftermath, dealers reduce their inventories, liquidity worsens, and yield spreads reflect a "fire sale" premium in bonds held my mutual funds. These effects are greater for bonds held by mutual funds with more Covid-19 exposure and less liquid portfolios.
Keywords: Municipal bonds, mutual fund fragility, liquidity, yield spread, COVID-19
JEL Classification: G14, G18, G21, G23, G24, G28
Suggested Citation: Suggested Citation