Forced Sales and Dealer Choice in OTC Markets

Abstract

Using novel trade-level data, we study how municipal bond mutual funds trade in response to daily flows. When forced to sell bonds to satisfy redemptions, funds prearrange fewer trades, sell more liquid bonds, and trade with more central dealers, who offer faster execution. Funds are especially likely to turn to more central dealers when trading lower rated bonds, when funds have low cash buffers, and when trading after periods of aggregate outflows. More central dealers charge higher markups when funds demand fast execution.

Keywords: dealers, fire sales, liquidity, municipal bonds, mutual funds, OTC markets

JEL Classification: G11, G23