‘Do Mutual Funds and ETFs Affect the Commonality in Liquidity of Corporate Bonds?’
by Efe Çötelioğlu
Swiss Finance Institute & USI Lugano
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The paper studies the effect of growing mutual fund and ETF ownership on the commonality in liquidity of bonds in their portfolios. Unpredictable liquidity needs of funds may give rise to correlated trading across underlying illiquid bonds. I document a positive and significant relationship between ETF ownership and liquidity commonality of investment-grade bonds, which suggests that ETFs reduce the possibility to diversify liquidity risk. In contrast, and unlike for equities, mutual fund ownership does not affect the co-movement in bond liquidity. I identify three channels that explain the differential impact of ETFs and mutual funds: flow-driven correlated trading, different investor clienteles, and ETF arbitrage activity.