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Swing Pricing for Mutual Funds: Breaking the Feedback Loop Between Fire Sales and Fund Runs

Agostino Capponi (), Paul Glasserman () and Marko Weber ()
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Agostino Capponi: Columbia University
Paul Glasserman: Office of Financial Research
Marko Weber: Columbia University

No 18-04, Working Papers from Office of Financial Research, US Department of the Treasury

Abstract: We develop a model of the feedback between mutual fund outflows and asset illiquidity. Alert investors anticipate the impact on a fund’s net asset value (NAV) of other investors’ redemptions and exit first at favorable prices. This first-mover advantage may lead to fund failure through a cycle of falling prices and increasing redemptions. Our analysis shows that (i) the first-mover advantage introduces a nonlinear dependence between a market shock and the aggregate impact of redemptions on the fund’s NAV; (ii) as a consequence, there is a critical magnitude of the shock beyond which a run brings down the fund; (iii) properly designed swing pricing transfers liquidation costs from the fund to redeeming investors and, by removing the nonlinearity stemming from the first-mover advantage, it reduces these costs and prevents fund failure. Achieving these objectives requires a larger swing factor at larger levels of outflows. The swing factor for one fund may also depend on policies followed by other funds.

Keywords: mutual funds; first-mover advantage; swing price; fire sales; financial stability (search for similar items in EconPapers)
Date: 2018-08-28
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