Mutual Fund Fragility, Dealer Liquidity Provisions, and the Pricing of Municipal Bonds

55 Pages Posted: 13 Nov 2020 Last revised: 16 Feb 2022

See all articles by Yi Li

Yi Li

Board of Governors of the Federal Reserve System

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management

Xing (Alex) Zhou

Board of Governors of the Federal Reserve System

Date Written: February 15, 2022

Abstract

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

Li, Yi and O'Hara, Maureen and Zhou, Xing (Alex), Mutual Fund Fragility, Dealer Liquidity Provisions, and the Pricing of Municipal Bonds (February 15, 2022). Available at SSRN: https://ssrn.com/abstract=3728943 or http://dx.doi.org/10.2139/ssrn.3728943

Yi Li (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-721-4576 (Phone)

HOME PAGE: http://sites.google.com/view/yili/

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3645 (Phone)
607-255-5993 (Fax)

Xing (Alex) Zhou

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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