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

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...

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Bibliographic Details
Published in:Journal of financial and quantitative analysis 2020-12, Vol.55 (8), p.2613-2640
Main Authors: Wang, Z. Jay, Zhang, Hanjiang, Zhang, Xinde
Format: Article
Language:English
Subjects:
Arbitrage
Bond markets
Bond ratings
Capital
Corporate bonds
Costs
Economic crisis
Hedge funds
Insurance companies
Investment policy
Investments
Liquidity
Mutual funds
Quantitative analysis
Redemption
Regulation of financial institutions
Regulatory reform
Sales
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Summary: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.
ISSN:0022-1090
1756-6916
DOI:10.1017/S0022109019000991