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Selection Bias in Mutual Fund Fire Sales

Published online by Cambridge University Press:  08 November 2022

Elizabeth A. Berger Open the ORCID record for Elizabeth A. Berger [Opens in a new window]
Elizabeth A. Berger*
Affiliation:
University of Houston C.T. Bauer College of Business
*
eberger@uh.edu
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Abstract

Liquidity trading following mutual fund outflows creates a potentially powerful empirical setting in which stock price variation is unrelated to changes in firm fundamentals. Instrumental variables (IVs) drawn from this setting impose an additional assumption that managers sell firms in proportion to portfolio weights. I show that this assumption causes selection bias in these IVs. It misallocates large price impacts to poorly performing, illiquid firms with lower growth – firms that managers systematically avoid selling. Simulations show that selection bias doubles the magnitude of regression coefficients and precludes potential fixes. Numerous recent studies exploiting these IVs should be reevaluated.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 58 , Issue 3 , May 2023 , pp. 1039 - 1077
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

I thank an anonymous referee, Alex Butler, Murillo Campello, Jennifer Conrad (the editor), Alan Crane, N. W. DuBois, John Edwards, Gustavo Grullon, Harrison Hong, Andrew Karolyi, Roni Michaely, David Ng, Natalia Sizova, Ioannis Spyridopoulos, Alberto Teguia, Margarita Tsoutsoura, and James Weston for thoughtful ideas, comments, and suggestions. I thank participants at the University of Manchester, 2015 WFA-CFAR Corporate Finance Conference, 2016 Financial Management Association Meetings, 2018 SFS Cavalcade Meetings, and 2018 WFA Meetings for helpful comments and suggestions.

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