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managers perform some amount of liquidity transformation because their ability to pool trades and space transactions over time flattens the price-quantity schedule faced by their investors. In this paper, we use the cash holdings of mutual funds that invest in equities and long-
Liquidity transformation – the creation of liquid claims that are backed by illiquid assets – is a key function of many financial intermediaries. Banks, for instance, hold illiquid loans but supply investors with highly liquid deposits. Many asset managers provide similar liquidity services through open-ending.
A key concern is that liquidity transformation increases the scope for fire sale externalities. Fundamental shocks can be amplified if open-ended funds hold illiquid assets. Consider, for example, a negative shock that results in poor returns for an open-ended fund.
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"Using a novel data set on the cash holdings of mutual funds, we show that cash plays an important role in how mutual funds provide liquidity to their investors. Rather than transacting in equities or bonds, mutual funds use cash to accommodate inflows and outflows.
Aug 15, 2016 · The study proposes a novel measure of liquidity transformation: funds’ cash management strategies. The study validates the measure and shows that liquidity transformation by asset managers is highly dependent on the traditional and shadow banking sectors.
Feb 18, 2016 · We study liquidity transformation in mutual funds using a novel data set on their cash holdings. To provide investors with claims that are more liquid than the underlying assets, funds engage in substantial liquidity management.
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What is liquidity transformation in asset management?
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Nov 5, 2020 · This is particularly true for funds with illiquid assets and at times of low market liquidity. We provide evidence suggesting that mutual funds’ cash holdings are not large enough to fully mitigate price impact externalities created by the liquidity transformation they engage in.
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