Working Paper: CEPR ID: DP14134
Authors: Jaewon Choi; Amil Dasgupta; Ji Yeol Jimmy Oh
Abstract: We show that supply side effects arising from the bond holdings of open-end mutual funds affect corporate credit risk through a refinancing channel. In our framework, bond funds exposed to flow-performance relationships become excessively reluctant to refinance bonds of companies with poor cash flow prospects. This lowers refinancing prices, enhancing incentives for strategic default, thus engendering a positive association between bond funds’ presence and credit risk. Empirically, we find that firms with a large share of mutual fund holdings experience increases in CDS spreads, particularly for funds that are more sensitive to flows. We address potential endogeneity issues by using fund acquisitions as exogenous shocks to funds’ flow concerns.
Keywords: fund flows; flow fragility; career concerns; bond rollover; default liquidity loop
JEL Codes: G23; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| flow-motivated bondholders (G32) | strategic default incentives of equityholders (G33) |
| strategic default incentives of equityholders (G33) | credit risk (G21) |
| presence of bond funds (G12) | credit risk (G21) |
| fund holdings (G23) | credit risk (G21) |
| fund holdings (G23) | refinancing prices (G19) |
| credit risk (G21) | refinancing prices (G19) |
| fund mergers (G34) | credit risk (G21) |
| fund family size (J13) | flow concerns (E50) |
| fund family size (J13) | credit risk (G21) |