Liquidity-Sensitive Trading and Corporate Bond Fund Fire Sales

In contrast to well-documented evidence reported in equity mutual fund studies, we find that fund flows have limited impact on corporate bond prices. We attribute this puzzling finding to liquidity management conducted by corporate bond funds. Such funds’ trading is highly sensitive to cash holdings and market liquidity. On average, they keep more than 15% of their assets in cash or cash-like securities and sell only 72 bps of bond holdings for one percent outflows, instead of selling on a one-for-one basis. Thus, flow-driven price pressure is pronounced only for bonds held by low-cash funds. Nonetheless, we find significant flow-driven price impact during market stress episodes such as the 2008 financial crisis and the 2013 “taper tantrum.” Also, low-cash funds represent an increasingly larger fraction of the corporate bond fund sector, suggesting that market-wide flow events can potentially have a substantial impact on corporate bond markets.