A dynamic theory of mutual fund runs and liquidity management

Yao Zeng

No 42, ESRB Working Paper Series from European Systemic Risk Board

Abstract: I model an open-end mutual fund investing in illiquid assets and show that the fund’s endogenous cash management can generate shareholder runs even with a flexible NAV. The fund optimally re-builds its cash buffers at time t + 1 after outflows at t to prevent future forced sales of illiquid assets. However, cash rebuilding at t + 1 implies predictable voluntary sales of illiquid assets, generating a predictable decline in NAV. This generates a first-mover advantage, leading to runs. A time-inconsistency problem aggravates runs: the fund may want to pre-commit not to re-build cash buffers but cannot credibly do so absent a commitment device. JEL Classification: G01, G21, G23, G32, G33, D92

Keywords: cash rebuilding; flexible NAV; illiquid assets; open-end mutual fund; shareholder runs (search for similar items in EconPapers)
Date: 2017-04
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Citations: View citations in EconPapers (43)

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Persistent link: https://EconPapers.repec.org/RePEc:srk:srkwps:201742

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