Abstract
Asset prices remain depressed for prolonged periods of time following mutual fund fire sales. We show that this price pressure from fire sales is partly due to asymmetric information which leads to an adverse selection problem for arbitrageurs. After a flow shock, fund managers choose to sell low-quality stocks. To measure this, we use short interest as a proxy variable for the unobservable negative signal managers use when selling. Following flow shocks, managers are significantly more likely to sell stocks which, ex ante, have high short interest. Moreover, these stocks experience future price drops that do not later reverse. In other words, fund managers have stock selling ability. Our findings suggest an explanation for the tendency of asset prices to remain depressed following fire sales: information asymmetries make it difficult for arbitrageurs to disentangle pure price pressure from negative information.
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