Cross-trading and Liquidity Management: Evidence from Municipal Bond Funds

Abstract The high flow-performance sensitivity of open-end municipal bond funds motivates fund managers to actively manage funding liquidity risk and reduce the costs of flow-driven transactions. We show that fund families use closed-end funds to provide liquidity to distressed open-end funds by coordinating cross-trading through the internal markets. Larger national funds, funds with lower cash holdings, and fund families with more flexible agency cross-trading policies engage more in liquidity-driven cross-trading. Such cross-trading improves the performance of open-end funds receiving the liquidity provision. Consistent with cross-fund subsidization and family-value maximization, fund families tend to engage low-value closed-end funds in cross-trading for liquidity management.