Fund Flows, Liquidity, and Asset Prices
Abstract
Unexpected fund flows may force mutual funds to liquidate assets, thereby depressing demand for securities that become illiquid during outflows. This paper shows that the liquidity beta on flows—defined as the comovement of a security’s liquidity costs with aggregate fund flow shocks—earns a significant risk premium in corporate bonds using firm-month fixed effects and a granular instrumental variables approach. The liquidity beta varies substantially even among bonds issued by the same firm and is largely driven by the interaction between redemption-driven forced sales and bond-level illiquidity. These findings highlight how fund flow shocks amplify liquidity risk through mutual funds' forced sales, shaping the cross section of expected corporate bond returns.
This paper was accepted by Lukas Schmid, finance.
Funding: This work was supported by the University of Melbourne and London Business School.
Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2025.01690.
