Is There Flow-Driven Price Impact in Corporate Bond Markets?

Abstract

We document the extent to which mutual fund flows drive price pressure in the corporate bond markets. In contrast to well-documented evidence reported in equity fund studies, fund flows have only limited impact on corporate bond prices. We attribute this puzzling finding to liquidity-sensitive trading conducted by corporate bond funds. Funds on average maintain 14% of their net assets in cash and selectively trade high liquidity bonds. They sell only 66 to 78 basis points of their bond holdings for one percent outflows of their total assets, instead of selling one-to-one. However, during market stress episodes such as the 2008 financial crisis and the Taper Tantrum, we observe significant flow-driven price pressure. Flows to low cash holding funds also exert temporary price pressure at the aggregate market level. Our results suggest that significant flows during market stress can potentially have destabilizing impact on the corporate bond markets despite funds’ liquidity management.