Liquidity analysis of Bond and Money Market Funds

Naoise Metadjer and Kitty Moloney
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Naoise Metadjer: Central Bank of Ireland

No 10/EL/17, Economic Letters from Central Bank of Ireland

Abstract: Monitoring liquidity risk of Money Market Funds (MMFs) and Investment Funds (IFs) is an important tool for the identification and assessment of systemic vulnerabilities. This paper highlights the importance of the definition of liquidity for the results of liquidity stress tests of IFs and MMFs. We present a prototype methodology for liquidity monitoring delineated on maturity, sector and credit ratings of securities held by a number of Irish-domiciled MMFs and bond funds. This analysis is facilitated by the granular, security-bysecurity portfolio holdings data collected by the Central Bank of Ireland on a monthly basis for MMFs and a quarterly basis for IFs. The methodology is inspired by the High Quality Liquid Assets (HQLA) classification framework which was initiated under Basel III. We compare HQLA to expected monthly redemptions and find the framework is appropriate for MMFs and sovereign bond funds who invest primarily in advanced economies, but less appropriate for more complex funds such as those who primarily invest in less developed (emerging) markets or lower credit quality (high yield) assets. By design emerging market and high yield funds are more likely to fail the test due to the fact that the HQLA framework applies heavy haircuts to the market value of any debt securities with lower than prime investment grade, regardless of the level of demand for such securities amongst investors. Future work will compare this methodology to a more market-based approach.

Date: 2017-09
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