Mariassunta Giannetti, Stockholm School of Economics
Chotibhak Jotikasthira, Southern Methodist University
Andreas Rapp, Federal Reserve Board of Governors
Martin Waibel, Stockholm School of Economics
Abstract: We show that after the introduction of the leverage ratio constraints on bank-affiliated dealers, bond mutual funds have engaged in more liquidity provision in investment-grade corporate bonds, and their performance has benefited. However, the liquidity and returns of investment-grade corporate bonds have become more exposed to aggregate outflows from the bond mutual fund industry. This suggests that the inability of bond funds to purchase bonds exposed to leverage constraints impacts market functioning. We show that mutual funds' missing liquidity provision helps explain which bonds experienced more severe deterioration in liquidity and returns at the onset of the COVID-19 pandemic.
Abstract: Investors act as a liquidity back-stop in the corporate bond market. By providing liquidity, investors help ease dealers' balance sheet constraints, especially during market stress. During the March 2020 Dash-for-Cash, in bonds where investors stopped providing liquidity, transaction costs rose by 38%. We find the composition of types of liquidity providers --- rather than just their presence --- shapes trading costs. Dealers relying on flexible-mandate investors, such as hedge funds, are more resilient to liquidity shocks. Dealers offer discounts to investors for past liquidity services to maintain liquidity provider networks. These discounts represent two-thirds of relationship discounts.
Discussant: Mahyar Kargar, University of Illinois-Urbana-Champaign
Abstract: This paper investigates how funding fragility posed by investors affects pricing dynamics in short-term funding markets. Utilizing the 2016 SEC reforms as exogenous funding shocks to the primary commercial paper (CP) markets, we find that CP issuers with high pre-reform reliance on MMFs incur an additional 4-basis-point increase in borrowing costs during sector-wide MMF withdrawals, yet experience no additional stress in funding volume or maturity structure. Analyzing decade-long data, we construct issuer-level MMF flow-based measures to gauge funding fragility and document consistent impacts on CP pricing. Our mechanism analyses reveal that issuers with weaker bargaining power face greater pricing penalties during MMF redemptions.
Discussant: Amy Wang Huber, University of Pennsylvania
