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

51 Pages Posted: 13 Nov 2020 Last revised: 10 May 2021

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: November 11, 2020

Abstract

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

Li, Yi and O'Hara, Maureen and Zhou, Xing (Alex), Mutual Fund Fragility, Dealer Liquidity Provisions, and the Pricing of Municipal Bonds (November 11, 2020). 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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