Schulich Research Sheds Light on How Mutual Funds Manage Liquidity in Times of Crisis
New research reveals how equity mutual funds manage their portfolios during periods of financial turbulence – and what this means for stock prices and overall market stability.
The study, titled Active Liquidity Management, Strategic Complementarities, and Market Price of Liquidity, is forthcoming in the journal Management Science and is sole-authored by Aleksandra Rzeźnik, Assistant Professor of Finance at Schulich.
Professor Rzeźnik’s research explores how investor redemptions during market stress drive mutual funds to rebalance their portfolios. Her findings show that funds engage in a “flight-to-liquidity,” selling off their most illiquid assets first in a systematic liquidation “pecking order.” This behaviour influences how liquidity is priced across the market, creating higher returns to liquidity providers during times of stress.
“When faced with uncertainty and investor outflows, fund managers tend to prioritize liquidity preservation,” says Rzeźnik. “This behaviour is not random – it follows a systematic pattern where the least liquid assets are sold off first, which has important implications for the market price of liquidity.”
The study also highlights the risks for funds most exposed to strategic complementarities – situations where widespread investor behaviour, such as mass withdrawals, amplifies financial instability. These funds adjust their portfolios more aggressively, intensifying overall market reactions.
By analyzing data from U.S. open-end equity mutual funds, including their responses during the 2008 financial crisis and other volatile periods, the research uncovers new insights into the demand-side drivers of liquidity premiums.
“Understanding how liquidity management works in practice is critical for policymakers, investors and market participants,” says Rzeźnik. “It helps explain why certain stocks and sectors are more affected during crises and these findings can inform strategies to lessen the impact of liquidity shocks.”
The full paper, Active Liquidity Management, Strategic Complementarities, and Market Price of Liquidity, is available here.
