Safe but fragile: Information acquisition,liquidity support and redemption runs |
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| Institution: | 1. Research Centre, Deutsche Bundesbank, Germany;2. University of Vienna and Vienna Graduate School of Finance (VGSF), Austria;1. Columbia Business School, 3022 Broadway, Uris Hall 601, New York 10027, NY, United States;2. International Monetary Fund, Research Department, 700 19th St, NW, Washington 20431, DC, United States;1. NUS Business School, National University of Singapore, Singapore;2. NUS Business School, National University of Singapore, Singapore;3. Hana Institute of Finance, South Korea;1. University of San Diego School of Business, San Diego, CA 92110 US |
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| Abstract: | This paper proposes a theory of redemption runs based on strategic information acquisition by fund managers. We argue that liquidity lines provided by third parties can be a source of financial fragility, as they incentivize fund managers to acquire private information about the value of their assets. This strategic information acquisition can lead to inefficient market liquidity dry-ups caused by self-fulfilling fears of adverse selection. By lowering asset prices, information acquisition also reduces the value of funds’ assets-under-management and may spur inefficient redemption runs by investors. Two different regimes can arise: one in which funds’ information acquisition incentives are unaffected by the volume of redemptions, and another where market and funding liquidity risk mutually reinforce each other. |
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