Mutual Funds’ Fire Sales and the Real Economy: Evidence from Hurricanes

This paper contributes to the recent debate on whether nonfundamental price dislocations affect real economic activities, using a novel and economically-grounded approach. Hurricanes create liquidity demand from investors living in disaster zones. This translates into additional outflows for mutual funds in the areas affected by hurricanes of about $2.5 billions. Such outflows cause fire sales, which are followed by temporary price dislocations in stocks unrelated to the natural disaster (-7% reverted within 10 months). The nonfundamental price drop induces firms to reduce investments by 4%. These results indicate that when the source of outflows is identified ex-ante and stems from investors’ liquidity needs unrelated to fund performance, the resulting nonfundamental price dislocations actually distort firms’ real decisions.

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