Mutual fund flight-to-liquidity

Category: Finance Brown Bag Seminar
When: 03 February 2016
, 02:00
 - 03:00
Where: DZ Bank (HoF E.20)
Speaker: Aleksandra Anna Rzeznik

Title: Mutual fund flight-to-liquidity 

Authors: Aleksandra Anna Rzeznik

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-to-liquidity 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.