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We show that supply side effects arising from the bond holdings of open-end mutual funds affect corporate credit risk. In our model, funds exposed to flow-performance relationships are reluctant to refinance bonds of companies with poor cash flow prospects fearing future investor outflows as a result of potential default events.
This lowers refinancing prices, enhancing incentives for strategic default by equityholders, engendering a positive association between bond funds’ presence and credit risk. Empirically, we find that in firms with poor cash flow prospects, active fund bond holdings are associated with increased CDS spreads, more so when funds are more sensitive to flows. We use an instrumental variable approach and a quasi-experiment based on the departure of Bill Gross from PIMCO to address the endogeneity between fund holdings and credit spreads.
Recent research shows that a high wage gap between managers and workers identifies better-performing firms, but the stock market does not seem to price...
Using a sample of commercial aircraft transactions, the paper decomposes the raw fire sale discount on sales of aircraft by distressed airlines into...