bond liquidty white paper - Do buy-side institutions supply...

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Electronic copy available at: https://ssrn.com/abstract=3003189 Do buy-side institutions supply liquidity in bond markets? Evidence from mutual funds* Amber Anand, Syracuse University Chotibhak Jotikasthira, Southern Methodist University Kumar Venkataraman, Southern Methodist University Abstract This study presents new evidence on buy-side institutions as a channel of liquidity supply in the corporate bond market. Using bond transactions data, we aggregate the inventory positions of bond dealers, and identify inventory cycles. We classify a bond fund’s trading style as liquidity supplying (demanding) if the changes in bond holdings exhibit a propensity to absorb (further strain) the aggregate dealer positions. Between 2003 and 2014, bond funds on average tend to demand liquidity; however, trading styles vary across bond funds and are persistent over time. Higher flexibility in portfolio holdings is associated with a liquidity supplying trading style. A liquidity supplying trading style earns higher future fund returns after controlling for portfolio attributes and factor risk exposures. These results suggest that trading style contains useful information for investors in selecting bond funds and that bond market liquidity can be enhanced by developing platforms that facilitate participation by buy-side institutions. Keywords: Bond liquidity; buy-side institutions; dealer inventory; mutual funds; fund performance. First Draft: July 14, 2017 --------------------------------------------------------------------------------------------------------------------- * The authors thank the Finance Industry Regulatory Authority (FINRA), and in particular, Alie Diagne, Ola Persson, and Jonathan Sokobin for provision of data.
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Electronic copy available at: https://ssrn.com/abstract=3003189 Do buy-side institutions supply liquidity in bond markets? Evidence from mutual funds Abstract This study presents new evidence on buy-side institutions as a channel of liquidity supply in the corporate bond market. Using bond transactions data, we aggregate the inventory positions of bond dealers, and identify inventory cycles. We classify a bond fund’s trading style as liquidity supplying (demanding) if the changes in bond holdings exhibit a propensity to absorb (further strain) the aggregate dealer positions. Between 2003 and 2014, bond funds on average tend to demand liquidity; however, trading styles vary across bond funds and are persistent over time. Higher flexibility in portfolio holdings is associated with a liquidity supplying trading style. A liquidity supplying trading style earns higher future fund returns after controlling for portfolio attributes and factor risk exposures. These results suggest that trading style contains useful information for investors in selecting bond funds and that bond market liquidity can be enhanced by developing platforms that facilitate participation by buy-side institutions.
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Electronic copy available at: https://ssrn.com/abstract=3003189 1 I. Introduction Liquidity in the corporate bond market has received considerable attention in recent years. During the last decade, the outstanding amount of corporate bonds has increased from $4.8 trillion in 2006 to $8.5
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