Short of Cash? Convex Corporate Bond Selling By Mutual Funds and Price Fragility

57 Pages Posted: 25 Oct 2023

See all articles by Minsoo Kim

Minsoo Kim

University of Melbourne

Oliver Randall

University of Melbourne - Department of Finance

Date Written: September 19, 2023

Abstract

We show cash shortfall, i.e. outflows in excess of cash holdings, has quantitatively important implications for corporate bond funds’ trading and price fragility. We find corporate bond selling is strongly convex in cash shortfall, while Treasury selling is closer to linear. We solve a theoretical model that explains these patterns from dual effects: a higher cash shortfall today increases both the expected future shortfall and liquidity costs. Consistent with this, we show cash shortfall amplifies the sensitivity of corporate bond selling to outflows. Surprisingly, unless there is a cash shortfall, we find no relationship between corporate bond selling and outflows for investment-grade bond funds. In contrast, Treasury selling depends only on outflows, independent of cash shortfall. We find downward price pressure from shortfall-induced trading in corporate bond returns, particularly large during the Covid-19 crisis. This price fragility is becoming more concerning as we find cash shortfall has trended upward recently.

Keywords: Cash Shortfall, Trading by Mutual Funds, Corporate Bonds, Liquidity Management, Price Pressure, Fund Flows, Pecking Order

JEL Classification: G11, G12, G20, G23

Suggested Citation

Kim, Minsoo and Randall, Oliver, Short of Cash? Convex Corporate Bond Selling By Mutual Funds and Price Fragility (September 19, 2023). Available at SSRN: https://ssrn.com/abstract=4585667 or http://dx.doi.org/10.2139/ssrn.4585667

Minsoo Kim (Contact Author)

University of Melbourne ( email )

Melbourne
Australia

HOME PAGE: http://https://www.minsookim.net/

Oliver Randall

University of Melbourne - Department of Finance ( email )

Australia

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