What are the Actual Effects of Cash Holdings? Evidence from the Mutual Fund Industry

I show that mutual fund cash holdings can adversely affect the market liquidity of their stocks. I study the events when a stock’s mutual fund owners experience outflows. I find that the stocks held or sold by cash rich funds become more illiquid compared to the case with cash poor funds. Facing investor redemptions, cash poor funds are likely to engage in forced fire sale while cash rich funds are likely to engage in voluntary information sale. Other market participants are unwilling to provide liquidity to stocks held or sold by cash rich funds, since any selling on these stocks is more likely to be due to adverse selection. In contrast, any selling on stocks held or sold by cash poor funds is likely to be driven by funding liquidity needs followed by future price reversal