1 / 22

Payoff Complementarities and Financial Fragility: Evidence from Mutual Fund Outflows

Payoff Complementarities and Financial Fragility: Evidence from Mutual Fund Outflows. Qi Chen (Duke) Itay Goldstein (Wharton) Wei Jiang (Columbia). Payoff Complementarities: Theory and Evidence. Payoffs to take an action increases when others do the same.

korbin
Télécharger la présentation

Payoff Complementarities and Financial Fragility: Evidence from Mutual Fund Outflows

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. PayoffComplementarities and Financial Fragility: Evidence from Mutual Fund Outflows Qi Chen (Duke) Itay Goldstein (Wharton) Wei Jiang (Columbia)

  2. Payoff Complementarities: Theory and Evidence • Payoffs to take an action increases when others do the same. • Optimizing agents could end up in an inferior equilibrium. • Extreme cases: Bank runs (Diamond and Dybvig, 1983); Currency attacks (Morris and Shin, 1998). • Key parameters: • Degree of complementarities affects the level of fragility. • Ease of internalization/coordination affects the equilibrium. • Empirical evidence? • Hard to show (data constraints/missing variables). • This paper is the first attempt.

  3. Payoff complementarities in mutual funds redemption Day 1 Day 3 Day 4 … Day 2 At 3:59pm, investor i submits redemption Mutual fund trades to raise the cash or to restore cash balance. NAV determined by the closing price at 4:00pm • Remaining shareholders bear most of the cost of redemption. • Direct: commissions, bid-ask spread, price impact. • Indirect: forced deviation from desired portfolio; liquidity-based trading. • Tax? • The costs are higher when the underlying assets are less liquid.

  4. Extent of the problem • Edelen (1999): On average, 76% of gross outflows lead to forced sell; 2.2% lowered return per unit of forced trading. • Calibrate to data from Christofferson, Evans, and Musto (2005): With large redemption (95th to 99th percentile) and illiquid assets, damage amounts to 50 bps to more than 100 bps in a month. • Alexander, Cici, and Gibson (2007): Stocks sold for liquidity outperform by 1.55% annually. • Our story applies mostly to the marginal investor making a redemption decision, not to the average investor. • Most investors do not trade much (Johnson (2006) and Agnew, Pierluigi, and Sunden (2003)) . • Total runs on mutual funds are very uncommon (there have been a few cases since 2006).

  5. Remedies of the problem • By funds: • Attempts to predict flows (usually difficult) • Cash reserves (costly to performance) • Restriction on redemption frequency (compromising liquidity to investors) • Emergency rules: suspension of redemption; redemption in kind…(seldom used) • By the market: • “Reflow” (very recent) • By SEC: • Redemption fee formalized in 2005. • Summary: These are mitigating measures that do not eliminate the problem.

  6. Simple setup • Parameters: • Returns R1 and R2. NAV(t=1) = R1. • Proportion of redeemers: 0 ≤ N < 1. • Liquidity: need to sell $(1+ λ) in order to raise $1. • Payoff at t = 2: R1 R2 [1-(1+ λ)N]/(1-N). • With inflows I(R1): R1 R2 [1-(1+ λ)max{0,(N-I(R1))}] 1-max{0,(N-I(R1))}

  7. Designing the Empirical Tests from Theory • Two Premises: • Complementarities arise when funds experience outflows. • Complementarities are stronger when funds hold more illiquid assets. • Based on a global-game model (Morris and Shin, 1998; Goldstein and Pauzner, 2005): • H1: Conditional on low performance, funds that hold illiquid assets will experience more outflows. • i.e., fragility increases in complementarities. • Sharpen the test (based on Corsetti et al., 2004): • H2: Pattern weakens when fund is held by large investors. • i.e., large investors internalize the externality.

  8. Empirical implications: flow-to-performance relation Net Flows Flows w/o complementarities (liquid assets) Past Performance Institutional shares (illiquid assets) Flows w/ complementarities (illiquid assets)

  9. Data • CRSP/Morningstar: 4,393 actively-managed equity funds from 1995-2005. Main analysis conducted on fund-share basis. • Distinguish between liquid funds and illiquid funds. • Illiquid funds are: small-cap & mid-cap equity funds (domestic or international), or single-country funds excluding US, UK, Japan and Canada. Altogether 1,227 funds. • Or, portfolio weighted average of Amihud (2002) measure. • Distinguish between large and small shareholders. • Institutional vs. retail share class. About 22% of all fund shares are institutional. • Minimum initial purchase.

  10. Regression Specification

  11. Liquidity and Outflows:Hypothesis 1

  12. The Effect of Large Investors (all fund shares): Hypothesis 2 • Illiquid funds see more sensitive flows only when they are retail-oriented: • Support our Hypothesis 2 (about internalization/coordination). • Not supported by the “missing variable” hypothesis. • Can it be supported by the “information story?”

  13. Predictability of fund return (in the absence of extreme outflows)

  14. A cleaner (and out-of-sample) test offered by closed-end funds (1988-2004)

  15. Large Investors Only: The Effect of Clientele Large investors (the same clientele) behave differently in institutional- and retail-oriented funds.

  16. Alternative and out-of-sample tests • Using refined holding-data liquidity measures on the sub-sample of U.S. equity funds, we obtain similarly supportive results for both hypotheses. • Outflows negatively affect funds future performance (controlling for serial correlations of returns). The effect is 20 bps higher for bottom-quartile liquidity funds after a month of 5% or higher net outflows. • Funds attempt to accommodate such effects. More illiquid funds are more likely to: • hold larger cash reserve, • implement redemption fee, with more stringent conditions (higher fee and/or longer restriction period after 2005.

  17. Alternative Measures of Liquidity More illiquid funds experience more outflow after poor performance; Less so in the presence of large institutional investors. The above results also hold in the subsample of illiquid funds.

  18. Marginal Liquidity Funds can sell the most liquid portion of the portfolio facing outflows. Marginal liquidity maintains the same prediction.

  19. Outflow, Liquidity, and Performance Outflow negatively affects funds future performance above and beyond the momentum effect, only significantly for illiquid funds.

  20. Fund Policies • More illiquid funds are more likely to • hold larger cash reserve, • implement redemption fee, with more stringent conditions (higher fee and/or longer restriction period).

  21. Main Contributions • Mutual fund literature. • e.g., Brown, Harlow, and Starks (1996), Chevalier and Ellison (1997), Sirri and Tufano (1998), and Zheng (1999). • Show that interaction among investors matters for mutual fund flows. • Financial fragility literature. • Demonstrate that payoff complementarities contribute to financial fragility. • Show the vulnerability of open-end financial institutions (Stein, 2005; Cherkes, Sagi, and Stanton, 2006). • Policy implications. • Testing predictions from models with strategic complementarities. • e.g., Manski (1993), Glaeser, Sacerdote, and Scheinkman (2003), and Matvos and Ostrovsky (2006). • Show that global games prove to be a useful tool to provide empirical implications that can be taken to the data.

  22. Liquidity and Outflows:Semi-Parametric Approach

More Related