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Economic Fragility, Liquidity, and Risk: The Behavior of Mutual Funds during Crises

Authors: Graciela Laura Kaminsky, Richard K. Lyons, and Sergio Schmukler
Pub. Date: January 29, 2000
Full Text: Adobe Acrobat (PDF) [225 KB]

A myriad of currency crises have plagued the last decade of the 20th century. These crises were not confined to individual nations, or even regions. The Thai crisis engulfed—within days—Malaysia, Indonesia, and the Philippines. The Russian crisis spread as fast to countries as far apart as Brazil and Pakistan. Even developed countries have been affected, with the Russian default/devaluation reverberating in financial markets in the United States, Germany, and Great Britain. This study examines the role of mutual funds in spreading crises. It focuses on whether funds’ flows are linked to emerging economies’ degree of fragility, their capital-market openness and liquidity, and their level of country risk. It also examines in particular detail the behavior of U.S.-based Latin-American mutual funds, with special attention to the effects of redemptions on funds’ management of their liquid positions. We find that economic fragility is not the only factor that triggers withdrawals. Liquidity is also important. In particular, faced by investor redemptions, mutual-fund managers tend to liquidate their most liquid

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