Money in the Right Hands

Abstract

We study the price effects of mutual fund fire sales and index reconstitutions from a demand-based perspective. We introduce a stock-level measure of specialized demand, capturing the available investment capacity of investors likely to have a high valuation for a stock and find that it determines non-fundamental price discounts. When specialized, elastic demand is scarce, we observe the price pressure documented in the literature. Specialized demand does not proxy for informed trading, and asset quality or adverse selection are unlikely to explain our results. Rather, inefficient allocations induced by fire sales lead to transiently higher discount rates and price pressure.

Keywords: Mutual funds, Demand-based asset pricing, Fire sales, Liquidity, Market efficiency

JEL Classification: G11, G12, G14, G23