Bond Funds and Credit Risk

Amil Dasgupta, Jaewon Choi and Ji Yeol Jimmy Oh

No 14134, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We show that supply side effects arising from the bond holdings of open-end mutual funds affect corporate credit risk through a refinancing channel. In our framework, bond funds exposed to flow-performance relationships become excessively reluctant to refinance bonds of companies with poor cash flow prospects. This lowers refinancing prices, enhancing incentives for strategic default, thus engendering a positive association between bond funds’ presence and credit risk. Empirically, we find that firms with a large share of mutual fund holdings experience increases in CDS spreads, particularly for funds that are more sensitive to flows. We address potential endogeneity issues by using fund acquisitions as exogenous shocks to funds’ flow concerns.

Keywords: Fund flows; Flow fragility; Career concerns; Bond rollover; Default-liquidity loop (search for similar items in EconPapers)
JEL-codes: G23 G32 (search for similar items in EconPapers)
Date: 2019-11
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Working Paper: Bond funds and credit risk (2022)
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