Passive Demand and Active Supply: Evidence from Maturity-Mandated Corporate Bond Funds

Abstract

We identify a novel exogenous demand shock caused by passive funds in corporate bond markets. Passive fund demand for corporate bonds displays discontinuity around the maturity cutoffs separating long-term, intermediate-term, and short-term bonds. Using a novel identification strategy, we show that these non-fundamental passive demand shifts i) lead to predictable upward price pressure, and ii)  spill over to primary markets, causing lower issuing yield spreads, and firms engaging in debt market timing by substituting bank debt with bond financing. We show how SEC regulations and provisions affect the execution of passive strategies and their transmission to the real economy.

Keywords: demand shifts, passive funds, corporate bonds, demand elasticity, ETFs, mutual funds, price pressure, cross-trading, capital structure, market timing, SEC, regulation