DP14817 Debt De-risking

Author(s):	Jannic Cutura, Gianpaolo Parise, Andreas Schrimpf
Publication Date:	July 2020
Date Revised:	July 2020
Keyword(s):	bonds, De-risking, liquidity, Mutual funds, swing pricing, tournaments
JEL(s):	E43, G11, G23, G32
Programme Areas:	Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=14817

We examine the incentive of corporate bond fund managers to manipulate portfolio risk in response to competitive pressure. We find that bond funds engage in a reverse fund tournament in which laggard funds actively de-risk their portfolios, trading-off higher yields for more liquid and safer assets. De-risking is stronger for laggard funds that have a more concave sensitivity of flows-to-performance, in periods of market stress, and when bond yields are high. We provide evidence that debt de-risking also reduces ex post liquidation costs by mitigating the investors' incentive to run ex ante. We argue that, in the presence of de-risking behaviors, flexible NAVs (swing pricing) may be counter-productive and induce moral hazard.