[Research Seminar 2019.11.07] Bond Funds and Credit RiskSpeaker : Ji Yeol Jimmy Oh
We show both theoretically and empirically the extent to which the supply side effects arising from mutual fund holdings matter for the credit risk of bond issuers. In our model, funds’ willingness to roll over expiring bonds depends on the flow consequences of future fund performance. The presence of these flow-motivated investors interacts with the incentives of strategic default by equityholders, which in turn increases the credit risk of bond issuers. We confirm our theoretical predictions in the data. Firms with a large share of mutual fund holdings subsequently experience increases in CDS spreads, particularly for funds that are more sensitive to fund flows. We also address the potential endogeneity issues in the relationship between fund holdings and credit risk, using fund acquisitions as exogenous shocks to funds’ flow concerns.