Hostname: page-component-586b7cd67f-2brh9 Total loading time: 0 Render date: 2024-11-29T19:01:38.522Z Has data issue: false hasContentIssue false
  • English
  • Français

Fire Sales and Impediments to Liquidity Provision in the Corporate Bond Market

Published online by Cambridge University Press:  04 November 2019

Z. Jay Wang ,
Hanjiang Zhang Open the ORCID record for Hanjiang Zhang [Opens in a new window]  and
Xinde Zhang
Z. Jay Wang
Affiliation:
Wang, [email protected], University of Oregon
Hanjiang Zhang
Affiliation:
Zhang, [email protected], Washington State University
Xinde Zhang*
Affiliation:
Zhang, [email protected], University of Arkansas
*
Zhang (corresponding author), [email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

We examine impediments to liquidity provision by mutual funds to insurance companies during corporate bond fire sales. We find that financial regulation and limited capital capacity significantly affect liquidity provision. Mutual funds reduced their purchase of fire-sale bonds following regulatory changes after the 2008–2009 financial crisis. Funds facing more capital constraints (proxied by smaller cash and Treasury holdings, less liquid corporate bond investments, higher redemption risk, and less active investment styles) provide less liquidity. Mutual funds actively investing in fire-sale bonds earn significant returns from liquidity provision and demonstrate superior overall skills in corporate bond investments.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 8 , December 2020 , pp. 2613 - 2640
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We thank an anonymous referee, Hendrik Bessembinder (the editor), Xuanjuan Chen, Zhuo Chen, Clemens Sialm, Zhimin Wang, and seminar participants at the University of International Business and Economics, the PBC School of Finance at Tsinghua University, the 2015 China International Conference in Finance, and the 2016 Financial Management Association Annual Meetings for their helpful comments. Supports from the Program for Innovative Research Team of Shanghai University of Finance and Economics (IRTSHUFE), Nanyang Technological University, and Our Lady of the Lake University are gratefully acknowledged.

References

Ambrose, B. W.; Cai, N. K.; and Helwege, J.. “Forced Selling of Fallen Angels.” Journal of Fixed Income, 18 (2008), 72–85.CrossRefGoogle Scholar
Bao, J.; O’Hara, M.; and Zhou, X. A.. “The Volcker Rule and Corporate Bond Market Making in Times of Stress.” Journal of Financial Economics, 130 (2018), 95–113.CrossRefGoogle Scholar
Bessembinder, H.; Jacobsen, S.; Maxwell, W.; and Venkataraman, K.. “Capital Commitment and Illiquidity in Corporate Bonds.” Journal of Finance, 73 (2018), 1615–1661.CrossRefGoogle Scholar
Brunnermeier, M., and Pedersen, L. H.. “Market Liquidity and Funding Liquidity.” Review of Financial Studies, 22 (2009), 2201–2238.CrossRefGoogle Scholar
Cella, C.; Ellul, A.; and Giannetti, M.. “Investors’ Horizons and the Amplification of Market Shocks.” Review of Financial Studies, 26 (2013), 1607–1648.CrossRefGoogle Scholar
Chen, Q.; Goldstein, I.; and Jiang, W.. “Payoff Complementarities and Financial Fragility: Evidence from Mutual Fund Outflows.” Journal of Financial Economics, 97 (2010), 239–262.CrossRefGoogle Scholar
Chernenko, S., and Sunderam, A.. “Liquidity Transformation in Asset Management: Evidence from the Cash Holdings of Mutual Funds.” Working Paper, Purdue University (2016).CrossRefGoogle Scholar
Cici, G., and Gibson, S.. “The Performance of Corporate Bond Mutual Funds: Evidence Based on Security-Level Holdings.” Journal of Financial and Quantitative Analysis, 47 (2012), 159–178.CrossRefGoogle Scholar
Coval, J., and Stafford, E.. “Asset Fire Sales (and Purchases) in Equity Markets.” Journal of Financial Economics, 86 (2007), 479–512.CrossRefGoogle Scholar
Daniel, K.; Grinblatt, M.; Titman, S.; and Wermers, R.. “Measuring Mutual Fund Performance with Characteristic-Based Benchmarks.” Journal of Finance, 52 (1997), 1035–1058.CrossRefGoogle Scholar
Duffie, D.“Presidential Address: Asset Price Dynamics with Slow-Moving Capital.” Journal of Finance, 65 (2010), 1237–1267.CrossRefGoogle Scholar
Duffie, D.“Market Making under the Proposed Volcker Rule.” Working Paper, Rock Center for Corporate Governance at Stanford University (2012).CrossRefGoogle Scholar
Duffie, D.; Gârleanu, N.; and Pedersen, L. H.. “Over-the-Counter Markets.” Econometrica, 73 (2005), 1815–1847.CrossRefGoogle Scholar
Duffie, D.; Gârleanu, N.; and Pedersen, L. H.. “Valuation in Over-the-Counter Markets.” Review of Financial Studies, 20 (2007), 1865–1900.CrossRefGoogle Scholar
Duffie, D., and Strulovici, B.. “Capital Mobility and Asset Pricing.” Econometrica, 80 (2012), 2469–2509.Google Scholar
Ellul, A.; Jotikasthira, C.; and Lundblad, C. T.. “Regulatory Pressure and Fire Sales in the Corporate Bond Market.” Journal of Financial Economics, 101 (2011), 596–620.CrossRefGoogle Scholar
Elton, E. J.; Gruber, M. J.; and Blake, C. R.. “Fundamental Economic Variables, Expected Returns, and Bond Fund Performance.” Journal of Finance, 50 (1995), 1229–1256.CrossRefGoogle Scholar
Fulkerson, J. A., and Riley, T. B.. “Mutual Fund Liquidity Costs.” Financial Management, 46 (2017), 359–375.CrossRefGoogle Scholar
Gaspar, J.-M.; Massa, M.; and Matos, P.. “Shareholder Investment Horizons and the Market for Corporate Control.” Journal of Financial Economics, 76 (2005), 135–165.CrossRefGoogle Scholar
Goldstein, I.; Jiang, H.; and Ng, D. T.. “Investor Flows and Fragility in Corporate Bond Funds.” Journal of Financial Economics, 126 (2017), 592–613.CrossRefGoogle Scholar
Green, R. C.; Hollifield, B.; and Schürhoff, N.. “Financial Intermediation and the Costs of Trading in an Opaque Market.” Review of Financial Studies, 20 (2007), 275–314.CrossRefGoogle Scholar
Grossman, S. J., and Miller, M. H.. “Liquidity and Market Structure.” Journal of Finance, 43 (1988), 617–633.CrossRefGoogle Scholar
Gutierrez, R. C.; Maxwell, W. F.; and Xu, D.. “On Economies of Scale and Persistent Performance in Corporate-Bond Mutual Funds.” Working Paper (2009), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1133959.Google Scholar
Jiang, H.; Li, D.; and Wang, A.. “Dynamic Liquidity Management by Corporate Bond Mutual Funds.” Working Paper, Michigan State University (2016).CrossRefGoogle Scholar
Kraus, A., and Stoll, H. R.. “Price Impacts of Block Trading on the New York Stock Exchange.” Journal of Finance, 27 (1972), 569–588.CrossRefGoogle Scholar
Lan, C.; Moneta, F.; and Wermers, R.. “Holding Horizon: A New Measure of Active Investment Management.” Working Paper, University of New South Wales (2018).Google Scholar
Mitchell, M.; Pedersen, L. H.; and Pulvino, T.. “Slow Moving Capital.” American Economic Review, Papers and Proceedings, 97 (2007), 215–220.CrossRefGoogle Scholar
Mitchell, M., and Pulvino, T.. “Arbitrage Crashes and The Speed of Capital.” Journal of Financial Economics, 104 (2012), 469–490.CrossRefGoogle Scholar
Pástor, L., and Stambaugh, R. F.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642–685.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R.. “Liquidation Values and Debt Capacity: A Market Equilibrium Approach.” Journal of Finance, 47 (1992), 1343–1366.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R.. “The Limits of Arbitrage.” Journal of Finance, 52 (1997), 35–55.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R.. “Fire Sales in Finance and Macroeconomics.” Journal of Economic Perspectives, 25 (2011), 29–48.CrossRefGoogle Scholar
Wooldridge, J. M. Econometric Analysis of Cross Section and Panel Data. Cambridge, MA: MIT Press (2002).Google Scholar
Yan, X. S.“The Determinants and Implications of Mutual Fund Cash Holdings: Theory and Evidence.” Financial Management, 35 (2006), 67–91.CrossRefGoogle Scholar