Liquidity risk in markets with trading frictions: What can swing pricing achieve?

Ulf Lewrick and Jochen Schanz

No 663, BIS Working Papers from Bank for International Settlements

Abstract: Open-end mutual funds expose themselves to liquidity risk by granting their investors the right to daily redemptions at the fund's net asset value. We assess how swing pricing can dampen such risks by allowing the fund to settle investor orders at a price below the fund's net asset value. This reduces investors' incentive to redeem shares and mitigates the risk of large destabilising outflows.Optimal swing pricing balances this risk with the benefit of providing liquidity to cash-constrained investors. We derive bounds, depending on trading costs and the share of liquidity-constrained investors, within which a fund chooses to swing the settlement price. We also show how the optimal settlement price responds to unanticipated shocks. Finally, we discuss whether swing pricing can help mitigate the risk of self-fulfilling runs on funds.

Keywords: Financial stability; mutual funds; regulation; liquidity insurance; trading frictions (search for similar items in EconPapers)
JEL-codes: C72 G01 G23 G28 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2017-10
New Economics Papers: this item is included in nep-cfn, nep-gth, nep-mst and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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