The Economic Implications of Money Market Fund Capital Buffers

Abstract

This paper considers the economic implications of supporting prime money market funds with capital buffers. The main findings are twofold. First, relatively small capital buffers are capable of absorbing daily fluctuations between a fund's shadow price and its amortized cost. The ability to absorb large scale defaults, however, would require a significantly larger and more costly buffer. Second, because a buffer is designed to absorb credit risk, capital providers demand compensation for bearing this risk. After adjusting for this cost, the returns available to prime money market fund shareholders are comparable to default free securities.