Mutual Fund Fragility, Dealer Liquidity Provisions, and the Pricing of Municipal Bonds
55 Pages Posted: 13 Nov 2020 Last revised: 16 Feb 2022
Date Written: February 15, 2022
Against the backdrop of COVID-19, we study how the interactions of mutual funds and dealers introduce fragility to the municipal bond market and induce lasting market impacts. During the crisis, trading surges while dealers' liquidity provision plunges for mutual-fund-held bonds, leading to greater price depressions in these bonds. Importantly, the crisis reshapes the market's perceptions of mutual fund fragility risks, with the aftermath-yield spreads widening significantly more for bonds with greater mutual fund exposures. Such post-crisis pricing effects reflect dealers' continued reluctance to provide liquidity for mutual-fund-held bonds and they are stronger for bonds whose mutual fund holders are more susceptible to investor runs.
Keywords: Municipal Bonds, Mutual Fund Fragility, Dealer, Liquidity, Pricing, COVID-19
JEL Classification: G14, G18, G21, G23, G24, G28
Suggested Citation: Suggested Citation