Fire-Sale Spillovers in Debt Markets

We assess fire-sale spillovers empirically using a new approach to measure network linkages across financial institutions and rich micro data for the universe of open-end fixed-income mutual funds. We find evidence that flows are interdependent across funds with asset class overlap, consistent with the hypothesis that one fund's redemptions may spill-over on to those of other funds by leading to distressed sales that adversely impact other funds' performance. We use several strategies to identify the causal link between any given fund's flows and those of its peers, including a regression discontinuity (RD) design that exploits sharp changes in peer flows around Morningstar 5-star ratings. The source of identification of our RD approach is quasi-random variation in peer flows around the arbitrary performance cutoffs used by Morningstar to assign their 5-star ratings, which is plausibly unrelated to changes in common industry fundamentals. Consistent with a fire-sale mechanism, not just fund flows, but also fund performance and liquidity, as well as the pricing of corporate bonds sold by funds under peer pressure, are adversely affected. Our approach yields simple measures of vulnerability of a fund family to system-wide flow pressures, which can be used for policy evaluation of alternative financial stability tools.