Can Swing Pricing Prevent Mutual Fund Runs and Fire Sales?

We develop a model of the feedback between mutual fund outflows and asset illiquidity. Alert investors anticipate the impact on the fund's net asset value of other investors' redemptions and exit first at favorable... [ view full abstract ]

We develop a model of the feedback between mutual fund outflows and asset illiquidity. Alert investors anticipate the impact on the fund's net asset value of other investors' redemptions and exit first at favorable prices. Our study shows that: (i) the first-mover advantage introduces a nonlinear dependence between initial price shock and resulting endogenous asset price change, amplifying the fire sale impact of the initial shock; (ii) beyond a critical shock threshold, a run causes the fund's failure; (iii) swing pricing transfers liquidation costs from the fund to redeeming investors and, importantly, reduces these costs and prevents fund failure.