Working Paper: NBER ID: w11357
Authors: Joshua D. Coval; Erik Stafford
Abstract: This paper examines asset fire sales, and institutional price pressure more generally, in equity markets, using market prices of mutual fund transactions caused by capital flows from 1980 to 2003. Funds experiencing large outflows (inflows) tend to decrease (increase) existing positions, which creates price pressure in the securities held in common by these funds. Forced transactions represent a significant cost of financial distress for mutual funds. We find that investors who trade against constrained mutual funds earn highly significant returns for providing liquidity when few others are willing or able. In addition, future flow-driven transactions are predictable, creating an incentive to front-run the anticipated forced trades by funds experiencing extreme capital flows.
Keywords: Asset Fire Sales; Institutional Price Pressure; Mutual Funds; Capital Flows
JEL Codes: G14; G32; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Forced sales by distressed mutual funds (G33) | Significant price pressure on the securities they hold (G12) |
| Significant outflows from mutual funds (G23) | Forced to sell holdings (G32) |
| Forced sales (G33) | Downward pressure on prices (D41) |
| Liquidity provision during fire sales (E44) | Significant abnormal returns (G14) |
| Inflow-driven purchases by mutual funds (G23) | Price pressures (E31) |
| Mutual fund trading behavior (G23) | Direct causal effect on market prices (G19) |
| Price reversals following forced transactions (D47) | Robust relationship between mutual fund flows and price movements (G19) |