Do Bond Mutual Funds Destabilize the Corporate Bond Market?

Abstract

Corporate bond mutual funds engage in liquidity transformation, raising concerns among academics and policymakers that correlated redemptions will destabilize the corporate bond market. However, estimating regressions that focus within issuer-quarter, I find little evidence that redemptions or resulting sell-offs push corporate bond prices below fundamental values. To reconcile my finding with contrasting findings for equity funds, I analyze both investor flows and portfolio management strategies. While bond fund investors demonstrate bank-run like behavior, bond fund managers hold a significant amount of liquid assets, allowing them to manage redemptions without excessively liquidating corporate bonds, even during the financial crisis.