Mutual Fund Liquidity Creation
38 Pages Posted: 30 Jan 2022
Date Written: January 27, 2022
We develop a novel measure of the dollar value of liquidity created by open-end mutual funds. Our measure compares the costs investors would have incurred had they traded on their own in response to liquidity shocks with the actual costs incurred by open-end mutual funds when trading to satisfy investor redemptions. Applying this measure to municipal bond mutual funds, we show that during the 2008-2017 period the average fund provides liquidity services worth 1.80 cents per dollar of gross redemptions or 50 basis points of fund assets per year. The aggregate value of liquidity services provided during this period was $14-22 billion. We decompose liquidity creation into three components: 1) flow netting, 2) liquidity management, and 3) trade execution, and explore the cross-sectional and time-series variation in liquidity creation.
Keywords: liquidity creation, municipal bonds, mutual funds
JEL Classification: G20, G23
Suggested Citation: Suggested Citation