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Liquidity transformation and financial stability: evidence from the cash management of open-end Italian mutual funds

Author

Listed:
  • Nicola Branzoli

    (Bank of Italy)

  • Giovanni Guazzarotti

    (Bank of Italy)

Abstract

A key structural vulnerability of open-end mutual funds is the potential liquidity mismatch between assets and liabilities. In this paper we study the management of liquidity transformation by open-end mutual funds through cash holdings and its potential implications for financial stability. Using supervisory data on Italian equity funds, we show that the amount of cash holdings reduces the probability that funds experiencing significant outflows make forced sales of assets that can potentially dislocate market valuations from fundamentals. Moreover, our results indicate that funds engaging in forced sales hold statistically more cash at the end of a month of financial distress than funds in financial distress that do not engage in forced sales. This evidence is consistent with recent empirical findings showing that funds facing significant redemptions may exacerbate periods of market stress by hoarding cash.

Suggested Citation

  • Nicola Branzoli & Giovanni Guazzarotti, 2017. "Liquidity transformation and financial stability: evidence from the cash management of open-end Italian mutual funds," Temi di discussione (Economic working papers) 1113, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:wptemi:td_1113_17
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    References listed on IDEAS

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    More about this item

    Keywords

    liquidity transformation; open-end mutual funds; financial stability;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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