Payoff Complementarities and Financial Fragility: Evidence from Mutual Fund Outflows

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Abstract
Theoretical work in financial economics suggests that payoff complementarities lead to financial fragility. Indeed, phenomena like bank runs and currency attacks are often attributed to the feature that investors are better off taking the same action taken by other investors. Due to data limitations, there is virtually no econometric evidence on the link between payoff complementarities and financial fragility. Using a model of global games, we apply this idea to the context of mutual funds and test it empirically. Based on the mutual-fund literature we use the illiquidity of a fund's assets as a proxy for the strength of strategic complementarities among the fund's investors. Consistent with our hypotheses, we find that conditional on low past performance, funds with illiquid assets will be subject to more redemptions than funds with liquid assets, and that this effect weakens in funds that are held primarily by large investors.

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