Mutual Funds and Stock and Bond Market Stability

Byline: Franklin R. Edwards (1), Xin Zhang (2) Abstract: The unprecedented growth of mutual funds has raised questions about the impact of mutual fund flows on stock and bond prices. Many believe that the equity bull market of the 1990s is attributable to the huge flows of funds into equity mutual funds during this period and that a withdrawal of those funds could send stock prices plummeting. This article investigates the relationship between aggregate monthly mutual fund flows (sales, redemptions, and net sales) and stock and bond monthly returns during a 30-year period beginning January 1961 utilizing Granger causality and instrumental variables analysis. With one exception, flows into stock and bond funds have not affected either stock and bond returns. The exception is 1971--1981, when widespread redemptions from equity mutual funds significantly depressed stock returns. In contrast, the magnitude of flows into both stock and bond funds are affected significantly by stock and bond returns. Author Affiliation: (1) Graduate School of Business, Columbia University, New York (2) The World Bank, Washington, DC Article History: Registration Date: 13/10/2004