Finance

Business

Liquidity risk

Fragility

Physical chemistry

Economics

Market liquidity

Chemistry

Mutual fund

Monetary economics

Financial system

Closed-end fund

Review of Financial Studies

We explore the link between mutual funds and fragility risk in the corporate bond market. We classify a fund’s trading style based on its responses to signals of large dealer inventories. Trading style is persistent and the majority of funds demand liquidity. Notably, a subset of funds earn positive alpha by intentionally supplying liquidity during periods of sustained customer selling (with transitory price effects). Liquidity-supplying funds maintain their relative trading style when facing large outflows and elevated market stress, thus alleviating fragility risk. Our results add nuance to existing evidence that mutual funds pose a threat to market stability.

Mutual Fund Trading Style and Bond Market Fragility