Implicit Guarantees And Risk Taking: Evidence From Money Market Funds
A firm's termination generates bankruptcy costs. This may create incentives for a firm's owner to bail out a firm in bankruptcy and to curb the firm's risk taking outside bankruptcy. The authors analyze the role of such implicit guarantees in the context of financial institutions that sponsor money market mutual funds. Their identification strategy exploits a large, exogenous expansion in risk-taking opportunities of money market funds during the period of August 2007 to August 2008. They find that a fund's response to the expansion depends on its sponsor's ability to provide implicit guarantees: funds sponsored by financial institutions with higher equity take on less risk than those sponsored by financial institutions with lower equity.