Payoff Complementarities and Financial Fragility: Evidence from Mutual Fund Outflows

50 Pages Posted: 2 Mar 2007

See all articles by Qi Chen

Qi Chen

Duke University - Fuqua School of Business

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

Wei Jiang

Columbia Business School - Finance and Economics

Date Written: February 2007

Abstract

Theoretical work in financial economics suggests that payoff complementarities lead to financial fragility. Indeed, phenomena like bank runs and currency attacks are often attributed to the feature that investors are better off taking the same action taken by other investors. Due to data limitations, there is virtually no econometric evidence on the link between payoff complementarities and financial fragility. Using a model of global games, we apply this idea to the context of mutual funds and test it empirically. Based on the mutual-fund literature we use the illiquidity of a fund's assets as a proxy for the strength of strategic complementarities among the fund's investors. Consistent with our hypotheses, we find that conditional on low past performance, funds with illiquid assets will be subject to more redemptions than funds with liquid assets, and that this effect weakens in funds that are held primarily by large investors.

Keywords: Payoff Complementarities, Financial Fragility, Mutual Fund Outflows, Global Games, Liquidity

Suggested Citation

Chen, Qi and Goldstein, Itay and Jiang, Wei, Payoff Complementarities and Financial Fragility: Evidence from Mutual Fund Outflows (February 2007). Available at SSRN: https://ssrn.com/abstract=966661 or http://dx.doi.org/10.2139/ssrn.966661

Qi Chen

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
(919) 660-7753 (Phone)

Itay Goldstein (Contact Author)

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0499 (Phone)

Wei Jiang

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
(212) 854-5553 (Phone)

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