Abstract
This paper examines the liquidity choices of mutual funds during times of market uncertainty. I find that when markets are uncertain, mutual funds actively increase the liquidity of their portfolio { often referred to as a `flight-to-liquidity.' In aggregate, mutual fund behaviour has implications for the market; the market driven flight-toliquidity places upward pressure on the liquidity premium. I examine the underlying mechanisms driving fund behaviour. I show that market volatility is associated with lower fund performance and withdrawals, which causes funds to adjust the composition of their portfolio towards more liquid assets in order to meet potential redemptions. This causal chain is consistent with Vayanos (2004), who argues that fund managers are investors with time-varying liquidity preferences due to threat of withdrawal. Aggregated over funds, the effect is substantial: a one standard deviation increase in my measure of flight-to-liquidity yields a 0.63 standard deviation increase in the excess return required for holding illiquid securities.
Original language | English |
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Publication date | 2016 |
Number of pages | 48 |
Publication status | Published - 2016 |
Event | The 28th Annual Conference of the Northern Finance Association. NFA 2016 - Fairmont Tremblant, Mont-Tremblant, Québec, Canada Duration: 16 Sept 2016 → 18 Sept 2016 Conference number: 28 http://www.northernfinance.org/ |
Conference
Conference | The 28th Annual Conference of the Northern Finance Association. NFA 2016 |
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Number | 28 |
Location | Fairmont Tremblant |
Country/Territory | Canada |
City | Mont-Tremblant, Québec |
Period | 16/09/2016 → 18/09/2016 |
Internet address |
Keywords
- Market uncertainty
- Financial crisis
- Liquidity
- Flight-to-inquidity
- Mutual funds
- Institutional investors
- Price pressure
- Idiosyncratic volability
- Systematic risk