Do Mutual Funds Flows Lead to Fire-sales and Pose Systemic Risk?

We propose a framework to link empirical models of systemic risk to theoretical network/ general equilibrium models used to understand the channels of transmission of systemic risk. The theoretical model allows for systemic risk due to interbank counterparty risk, common asset exposures/fire sales, and a “Minsky" cycle of optimism. The empirical model uses stock market and CDS spreads data to estimate a multivariate density of equity returns and to compute the expected equity return for each bank, conditional on a bad macro-outcome. Theses “cross-sectional" moments are used to re-calibrate the theoretical model and estimate the importance of the Minsky cycle of optimism in driving systemic risk.

Download Full-text

Optimization of Fire Sales and Borrowing in Systemic Risk

SIAM Journal on Financial Mathematics ◽

10.1137/18m1195425 ◽

2019 ◽

Vol 10 (1) ◽

pp. 68-88 ◽

Cited By ~ 2

Author(s):

Maxim Bichuch ◽

Zachary Feinstein

Keyword(s):

Systemic Risk ◽

Fire Sales

Download Full-text

The Growth and Changing Role of Passive Investments: A Critical Perspective on Index Mutual Funds and Exchange Traded Funds

Zeitschrift für Bankrecht und Bankwirtschaft ◽

10.15375/zbb-2016-0607 ◽

2016 ◽

Vol 28 (6) ◽

Author(s):

Wolfgang Bessler ◽

Heinz J. Hockmann

Keyword(s):

Corporate Governance ◽

Mutual Funds ◽

Systemic Risk ◽

Market Competition ◽

Product Market ◽

Product Market Competition ◽

Securities Market ◽

Market Quality ◽

Exchange Traded Funds ◽

Negative Effects

AbstractIndex Mutual Funds (IMF) and Exchange Traded Funds (ETF) have developed into widely-accepted and fast growing passive investment instruments, offering investors a low-cost investment alternative in well diversified portfolios. Allocating more into IMFs and ETFs is the investors’ natural response to the experience with and the disillusion about actively managed investment performance. Despite these positive effects, this shift in fund allocation raises substantial concerns about possible negative effects on securities market trading and market quality, on corporate governance and product market competition as well as on systemic risk. Most research so far does not provide significant evidence of negative effects on market quality, on securities market trading, and on systemic risk. Whether the shareholdings of IMF and ETF providers reduces product market competition and whether the concentration of voting rights negatively effects corporate governance requires further analysis. Some problems may occur if ETF and IMF providers team-up with active investors. Overall, the introduction of IMFs and ETFs on broad market indices should be viewed as a financial innovation that broadens the investment spectrum providing many benefits to investors especially when viewed relative to the meager performance and performance persistence of actively managed mutual funds.

Download Full-text

Measuring Systemic Risk Contribution of International Mutual Funds

Macroeconomic Shocks and Unconventional Monetary Policy ◽

10.1093/oso/9780198838104.003.0007 ◽

2019 ◽

pp. 146-158

Author(s):

Joshua Aizenman ◽

Yothin Jinjarak ◽

Huanhuan Zheng

Keyword(s):

Mutual Funds ◽

Systemic Risk ◽

Mutual Fund ◽

Global Financial Crisis ◽

Financial System ◽

Policy Implications ◽

Fund Managers ◽

Risk Contribution ◽

The Global Financial Crisis ◽

Global Financial System

The global financial crisis of 2007–09 has increased the attention of policymakers and academics on the scale and operation of interconnected financial systems, especially on what has become known as ‘too big to fail’ in the global financial system, including both bank and nonbanks. In this chapter, we study the systemic risk of the mutual fund sector in the global financial system. More specifically, this chapter provides new evidence of systemic risk contribution in the international mutual fund sector from 2000 to 2011. The empirical analysis tracks the systemic risk of 10,570 mutual funds investing internationally. The main findings suggest that the systemic risk contributions of international mutual funds are more than proportional given the fund’s size. Policy implications are discussed in terms of practicality of regulation, macroprudential approach, and risk-taking behaviour of fund managers.

Download Full-text

Illiquidity and All Its Friends

Journal of Economic Literature ◽

10.1257/jel.49.2.287 ◽

2011 ◽

Vol 49 (2) ◽

pp. 287-325 ◽

Cited By ~ 105

Author(s):

Jean Tirole

Keyword(s):

Adverse Selection ◽

Systemic Risk ◽

Information Acquisition ◽

Asset Prices ◽

Balance Sheet ◽

Market Value ◽

Capital Adequacy ◽

Fire Sales ◽

Liquidity Provision

The recent crisis was characterized by massive illiquidity. This paper reviews what we know and don't know about illiquidity and all its friends: market freezes, fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistic, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in place. The paper then analyzes market breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity, and analyzes how market value accounting and capital adequacy should react to asset prices. It concludes with a topical form of liquidity provision, monetary bailouts and recapitalizations, and analyzes optimal combinations thereof; it stresses the need for macro-prudential policies. (JEL E44, G01, G21, G28, G32, L51)

Download Full-text

Swing Pricing for Mutual Funds: Breaking the Feedback Loop Between Fire Sales and Fund Redemptions

Management Science ◽

10.1287/mnsc.2019.3353 ◽

2020 ◽

Vol 66 (8) ◽

pp. 3581-3602 ◽

Cited By ~ 1

Author(s):

Agostino Capponi ◽

Paul Glasserman ◽

Marko Weber

Keyword(s):

Mutual Funds ◽

Mutual Fund ◽

Feedback Loop ◽

Nonlinear Dependence ◽

Fire Sales ◽

First Mover Advantage ◽

Asset Value ◽

Net Asset Value ◽

The Impact ◽

First Mover

We develop a model of the feedback between mutual fund outflows and asset illiquidity. Following a market shock, alert investors anticipate the impact on a fund’s net asset value (NAV) of other investors’ redemptions and exit first at favorable prices. This first-mover advantage may lead to fund failure through a cycle of falling prices and increasing redemptions. Our analysis shows that (i) the first-mover advantage introduces a nonlinear dependence between a market shock and the aggregate impact of redemptions on the fund’s NAV; (ii) as a consequence, there is a critical magnitude of the shock beyond which redemptions brings down the fund; (iii) properly designed swing pricing transfers liquidation costs from the fund to redeeming investors and, by removing the nonlinearity stemming from the first-mover advantage, it reduces these costs and prevents fund failure. Achieving these objectives requires a larger swing factor at larger levels of outflows. The swing factor for one fund may also depend on policies followed by other funds. This paper was accepted by David Simchi-Levi, finance.

Download Full-text