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

Published online by Cambridge University Press:  04 November 2019

Z. Jay Wang ,
Hanjiang Zhang Open the ORCID record for Hanjiang Zhang [Opens in a new window]  and
Xinde Zhang
Z. Jay Wang
Affiliation:
Wang, zhiw@uoregon.edu, University of Oregon
Hanjiang Zhang
Affiliation:
Zhang, hanjiang.zhang@wsu.edu, Washington State University
Xinde Zhang*
Affiliation:
Zhang, czhang01@uark.edu, University of Arkansas
*
Zhang (corresponding author), czhang01@uark.edu
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Abstract

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.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 8 , December 2020 , pp. 2613 - 2640
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

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Footnotes

We thank an anonymous referee, Hendrik Bessembinder (the editor), Xuanjuan Chen, Zhuo Chen, Clemens Sialm, Zhimin Wang, and seminar participants at the University of International Business and Economics, the PBC School of Finance at Tsinghua University, the 2015 China International Conference in Finance, and the 2016 Financial Management Association Annual Meetings for their helpful comments. Supports from the Program for Innovative Research Team of Shanghai University of Finance and Economics (IRTSHUFE), Nanyang Technological University, and Our Lady of the Lake University are gratefully acknowledged.

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