Mutual Fund Trading Style and Bond Market Fragility
Review of Financial Studies, forthcoming
71 Pages Posted: 19 Jul 2017 Last revised: 8 Jun 2020
Date Written: May 7, 2020
We explore the link between mutual funds and fragility risk in the corporate bond market. We classify a fund’s trading style based on its responses to signals of large dealer inventories. Trading style is persistent and the majority of funds demand liquidity. Notably, a subset of funds earn positive alpha by intentionally supplying liquidity during periods of sustained customer selling (with transitory price effects). Liquidity supplying funds maintain their relative trading style when facing large outflows and elevated market stress, thus alleviating fragility risk. Our results add nuance to existing evidence that mutual funds pose a threat to market stability.
Keywords: Corporate bonds; dealers; mutual funds; fragility; liquidity; performance
JEL Classification: G10; G20
Suggested Citation: Suggested Citation