Bond Funds and Credit Risk

Bond Funds and Credit Risk

Jaewon Choi, Amil Dasgupta, Ji Yeol Jimmy Oh

Series number :

Serial Number: 
639/2019

Date posted :

November 22 2019

Last revised :

September 16 2020
SSRN Share

Keywords

  • Fund Flows • 
  • flow fragility • 
  • Career Concerns • 
  • bond rollover • 
  • default-liquidity loop

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.

Authors

Real name:
Jaewon Choi
Real name:
Ji Yeol Jimmy Oh