Payoff Complementarities and Financial Fragility: Evidence from Mutual Fund Outflows

The paper provides empirical evidence that strategic complementarities among investors generate fragility in financial markets. Analyzing mutual fund data, we find that, consistent with a theoretical model, funds with illiquid assets (where complementarities are stronger) exhibit stronger sensitivity of outflows to bad past performance than funds with liquid assets. We also find that this pattern disappears in funds where the shareholder base is composed mostly of large investors. We present further evidence that these results are not attributable to alternative explanations based on the informativeness of past performance or on clientele effects. We analyze the implications for funds’ performance and policies.

[1]  Itay Goldstein,et al.  Demand Deposit Contracts and the Probability of Bank Runs , 2002 .

[2]  Peter Tufano,et al.  Costly Search and Mutual Fund Flows , 1998 .

[3]  M. Spiegel,et al.  Cross-Sectional Variation in Stock Returns: Liquidity and Idiosyncratic Risk , 2005 .

[4]  Neil D. Pearson,et al.  Open-end mutual funds and capital-gains taxes 1 We would like to thank Morningstar, Inc., for provid , 1998 .

[5]  David Easley,et al.  Liquidity, Information, and Infrequently Traded Stocks , 1996 .

[6]  R. Wermers,et al.  Investing in Mutual Funds When Returns are Predictable , 2005 .

[7]  Sergio L. Schmukler,et al.  Do Depositors Punish Banks for Bad Behavior? Market Discipline, Deposit Insurance, and Banking Crises , 2001 .

[8]  Itay Goldstein,et al.  Activist Arbitrage: A Study of Open-Ending Attempts of Closed-End Funds , 2010 .

[9]  Christopher M. James,et al.  Investor monitoring and differences in mutual fund performance , 2006 .

[10]  Richard Stanton,et al.  A Liquidity-Based Theory of Closed-End Funds , 2006 .

[11]  David K. Musto,et al.  The Economics of Mutual-Fund Brokerage: Evidence from the Cross Section of Investment Channels , 2005 .

[12]  David Easley,et al.  Is Information Risk a Determinant of Asset Returns , 2002 .

[13]  Y. Amihud,et al.  Illiquidity and Stock Returns: Cross-Section and Time-Series Effects , 2000 .

[14]  L. Pedersen,et al.  Asset Pricing with Liquidity Risk , 2003 .

[15]  S. Morris,et al.  Liquidity Black Holes , 2003 .

[16]  Gregory Kadlec,et al.  On the Perils of Financial Intermediaries Setting Security Prices: The Mutual Fund Wild Card Option , 2001 .

[17]  R. H. Smith,et al.  Investing in mutual funds when returns are predictable , 2006 .

[18]  Gary B. Gorton.  Banking panics and business cycles , 1988 .

[19]  Woodrow T. Johnson.  Predictable Investment Horizons and Wealth Transfers Among Mutual Fund Shareholders , 2003 .

[20]  Lu Zheng.  Is Money Smart? A Study of Mutual Fund Investors' Fund Selection Ability , 1999 .

[21]  Guillaume Plantin.  Self-Fulfilling Liquidity and the Coordination Premium , 2004 .

[22]  Gordon J. Alexander,et al.  Does Motivation Matter When Assessing Trade Performance? An Analysis of Mutual Funds , 2006 .

[23]  Liliana B. Schumacher.  Bank runs and currency run in a system without a safety net: Argentina and the `tequila’ shock , 2000 .

[24]  Bernard W. Silverman,et al.  Density Estimation for Statistics and Data Analysis , 1987 .

[25]  Guillaume Plantin.  Learning by Holding and Liquidity , 2009 .

[26]  B. Silverman.  Density estimation for statistics and data analysis , 1986 .

[27]  W. Johnson,et al.  Who Incentivizes the Mutual Fund Manager, New or Old Shareholders? , 2009 .

[28]  S. Morris,et al.  Does One Soros Make a Difference? A Theory of Currency Crises with Large and Small Traders , 2001 .

[29]  Philip H. Dybvig,et al.  Bank Runs, Deposit Insurance, and Liquidity , 1983, Journal of Political Economy.

[30]  Daniel Paravisini,et al.  Public Information and Coordination: Evidence from a Credit Registry Expansion , 2010 .

[31]  C. Manski.  Identification of Endogenous Social Effects: The Reflection Problem , 1993 .

[32]  W. Johnson,et al.  Who Monitors the Mutual Fund Manager, New or Old Shareholders? , 2005 .

[33]  Jason T. Greene,et al.  The Dilution Impact of Daily Fund Flows on Open-End Mutual Funds , 2000 .

[34]  K. Brown,et al.  Of Tournaments and Temptations: An Analysis of Managerial Incentives in the Mutual Fund Industry , 1996 .

[35]  The Dark and the Bright Side of Liquidity Risks: Evidence from Open-End Real Estate Funds in Germany , 2010 .

[36]  Eric Zitzewitz,et al.  Who Cares About Shareholders? Arbitrage-Proofing Mutual Funds , 2002 .

[37]  Joshua D. Coval,et al.  Asset Fire Sales (and Purchases) in Equity Markets , 2005 .

[38]  Tarun Chordia,et al.  Liquidity and Autocorrelations in Individual Stock Returns , 2005 .

[39]  S. Morris,et al.  Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks" American Economic Review , 1996 .

[40]  X. Vives,et al.  Coordination Failures and the Lender of Last Resort: Was Bagehot Right after All? , 2002 .

[41]  Charles W. Calomiris,et al.  Contagion and Bank Failures During the Great Depression: The June 1932 Chicago Banking Panic , 1994 .

[42]  Ady Pauzner,et al.  Contagion of self-fulfilling financial crises due to diversification of investment portfolios , 2004, J. Econ. Theory.

[43]  E. Fama,et al.  Agency Problems and Residual Claims , 1983 .

[44]  Julie R. Agnew,et al.  Portfolio Choice and Trading in a Large 401(k) Plan , 2003 .

[45]  Jonathan D. Levin.  Bubbles and Crashes , 2006 .

[46]  W. Godwin.  Article in Press , 2000 .

[47]  Frank Zhang,et al.  Information Uncertainty and Stock Returns , 2004 .

[48]  Tarun Chordia.  The Structure of Mutual Fund Charges , 1996 .

[49]  P. Robinson.  ROOT-N-CONSISTENT SEMIPARAMETRIC REGRESSION , 1988 .

[50]  Sanford J. Grossman.  On the Impossibility of Informationally Efficient Markets , 1980 .

[51]  Chester Spatt,et al.  An Empirical Analysis of the Limit Order Book and the Order Flow in the Paris Bourse , 1995 .

[52]  A. Dasgupta.  FINANCIAL CONTAGION THROUGH CAPITAL CONNECTIONS: A MODEL OF THE ORIGIN AND SPREAD OF BANK PANICS , 2004 .

[53]  Russ Wermers,et al.  Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transactions Costs, and Expenses , 2000 .

[54]  Sixteenths: Direct Evidence on Institutional Execution Costs , 2001 .

[55]  S. Morris,et al.  Global Games: Theory and Applications , 2001 .

[56]  Joel Hasbrouck,et al.  Trading Costs and Returns for U.S. Equities: Estimating Effective Costs from Daily Data , 2009 .

[57]  Donald B. Keim,et al.  Valuable Information and Costly Liquidity: Evidence from Individual Mutual Fund Trades , 2006 .

[58]  Roger M. Edelen.  Investor flows and the assessed performance of open-end mutual funds , 1999 .

[59]  H. Carlsson,et al.  Global Games and Equilibrium Selection , 1993 .

[60]  M. Tyrell,et al.  Open-End Real Estate Funds in Germany: Genesis and Crisis , 2008, SSRN Electronic Journal.

[61]  Ronnie Sadka,et al.  Momentum and Post-Earnings-Announcement Drift Anomalies: The Role of Liquidity Risk , 2006 .

[62]  Charles W. Calomiris,et al.  Fundamentals, Panics and Bank Distress During the Depression , 2002 .

[63]  Raghuram G. Rajan,et al.  Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking , 1999, Journal of Political Economy.

[64]  A. Kyle.  Continuous Auctions and Insider Trading , 1985 .

[65]  Bruce Sacerdote,et al.  The Social Multiplier , 2002 .

[66]  R. Nagel,et al.  THE THEORY OF GLOBAL GAMES ON TEST: EXPERIMENTAL ANALYSIS OF COORDINATION GAMES WITH PUBLIC AND PRIVATE INFORMATION , 2004 .

[67]  Lars Peter Hansen,et al.  Advances in Economics and Econometrics , 2003 .

[68]  Glenn Ellison,et al.  Risk Taking by Mutual Funds as a Response to Incentives , 1995, Journal of Political Economy.