By Force of Flow: Investor Behavior and Money Market Fund Risk Allocations During the Eurozone Crisis∗

This paper studies fund flows and risk allocation decisions among prime money market funds (MMFs) during the 2011–2012 eurozone crisis. We exploit much more granular measures of fund credit risk and investor sophistication than previously employed in the literature. Empirically, we find that funds with greater credit risks experienced larger outflows during the eurozone crisis. This effect was substantially magnified among funds held by the most sophisticated investors. A key finding in our study is that these sophisticated investors were quicker to redeem when credit risk was attributable to European investments, relative to the same level of credit risk attributable to other regions. In turn, we find that managers of riskier funds serving sophisticated investors more aggressively reduced their European risk exposure, while often adding risk exposure to other regions. Taken together, our results suggest that sophisticated investors closely monitor money fund portfolios and increase redemptions when funds are on a riskier trajectory; in addition, fund managers appear to endogenize this threat by reallocating portfolio risks in a way that addresses redemptions. Our paper provides a unique perspective on this mechanism, as we study a period when, for the first time, investors had nearly real-time portfolio information on their money fund investments.