The Consequences of Fund-level Liquidity Requirements

45 Pages Posted: 20 May 2022 Last revised: 2 Jan 2024

See all articles by Indraneel Chakraborty

Indraneel Chakraborty

University of Miami - Department of Finance

Elia Ferracuti

Duke University - Fuqua School of Business

John C. Heater

Duke University - Fuqua School of Business

Matthew Phillips

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: May 10, 2023

Abstract

We investigate the effects that mutual fund liquidity requirements have on fragility. Starting in 2018, SEC Rule 22e-4 restricted ownership of illiquid securities in funds. As expected, post-rule, funds hold more liquid securities. Firms issuing illiquid securities face higher costs due to a smaller investor pool. However, higher liquidity does not ameliorate adverse shocks. Facing outflows, funds maintain cash levels and sell illiquid securities. This is because liquidity requirements are not sufficiently countercyclical: funds must maintain cash even when they should use it to mitigate flow pressures. Hence, outflows force funds to sell more illiquid securities post-rule change, unintentionally increasing fragility.

Keywords: Liquidity Requirements, Fragility, Corporate Bond Funds

JEL Classification: G23, G28

Suggested Citation

Chakraborty, Indraneel and Ferracuti, Elia and Heater, John C. and Phillips, Matthew, The Consequences of Fund-level Liquidity Requirements (May 10, 2023). Available at SSRN: https://ssrn.com/abstract=4081278 or http://dx.doi.org/10.2139/ssrn.4081278

Indraneel Chakraborty (Contact Author)

University of Miami - Department of Finance ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States
312-208-1283 (Phone)

HOME PAGE: http://sites.google.com/site/chakraborty/

Elia Ferracuti

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-1974 (Phone)

John C. Heater

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-1085 (Phone)

HOME PAGE: http://www.johnheater.com

Matthew Phillips

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

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