Does swing pricing reduce investment funds’ liquidity risk in times of market stress? – Evidence from the March-2020 episode

• Published in: The North American journal of economics and finance Vol. 72; p. 102118
• Main Authors: Shui-Tang Wu, Gabriel, Ho-Yeung Wong, Joe, Pak-Wing Fong, Tom
• Format: Journal Article
• Language: English
• Published: Elsevier Inc 01.05.2024
• Subjects: Financial econometrics; Financial stability; March-2020; Open-ended funds; Panel data regressions; Swing pricing; Financial stability; Panel data regressions; Financial econometrics; March-2020; Swing pricing; Open-ended funds
• ISSN: 1062-9408; 1879-0860
• DOI: 10.1016/j.najef.2024.102118

•While swing pricing could help to mitigate redemption pressures on open-ended funds in stress times, this study finds that the use of this tool could destabilize fund flows and incentivize risk-taking behaviour of the funds, which in turn amplify their redemption pressures.•Our findings suggest that a proper design and combination with other risk management tools (e.g. leverage limits to counteract risk-taking behaviour of the funds) may be warranted for swing pricing to function in a more effective way. The March-2020 episode has raised questions on whether the post-GFC reforms on the liquidity management of open-ended funds’ (OEFs) adequately contain their liquidity risk in times of market stress. Using an extensive dataset that covers this episode, our study shows that swing pricing could help to mitigate OEFs’ redemption pressures in times of market stress. However, the mitigating effect may be limited by two factors. First, swing pricing could encourage OEFs to raise leverage during normal periods, which may lead to substantial losses and amplify the redemption pressures in a stressful episode. Secondly, the swing pricing-led volatility of OEF returns is found to be associated with a larger volatility of OEFs’ flows. While our results suggest that swing pricing would be one effective tool for liquidity management of OEFs, it may come with “side effects”, including larger flow volatility and higher leverage. A proper design and combination with other risk management tools may be warranted for swing pricing to work in a more effective way.