Asset price bubbles and systemic risk in money market funds
Summary
Focus
We investigate how asset price bubbles interact with systemic risk in the money market fund (MMF) sector, using a large sample of more than 3,500 US dollar-denominated MMFs between 2004 and 2022. We examine whether MMF characteristics influence their contribution to systemic risk during both normal periods and episodes of exuberance in equity and real estate markets. Our paper bridges the literature on asset price bubbles, systemic risk and non-bank financial intermediation, highlighting the growing importance of MMFs within the global financial system. Particular attention is devoted to the role of market conditions in shaping the transmission of financial fragility across institutions and markets.
Contribution
We extend the analysis of bubbles and systemic risk beyond banks to non-bank financial institutions, focusing specifically on MMFs. We combine real-time bubble detection techniques with fund-level systemic risk measures and provide novel evidence on how MMF characteristics, fund type and market conditions jointly shape systemic vulnerability. We integrate state-of-the-art bubble detection procedures with panel-data systemic risk analysis, thus offering a unified empirical framework to study the interaction between financial exuberance and institutional fragility. We also contribute to the policy debate on the regulation and monitoring of non-bank financial institutions.
Findings
We find that large and government MMFs are generally associated with lower systemic risk, while prime MMFs contribute more strongly to financial fragility. However, during equity market booms, the growth of large MMFs can amplify systemic risk, indicating that MMF expansion becomes more destabilising under exuberant market conditions. Another important finding is that offshore US dollar-denominated MMFs behave similarly to US-domiciled funds, implying limited diversification benefits during periods of financial stress. Our research also shows that the systemic implications of MMF activity are highly state-dependent and become particularly relevant during periods of market exuberance and financial stress. The findings therefore support the need for closer monitoring of MMF growth dynamics and portfolio composition within macroprudential surveillance frameworks.
Abstract
We investigate the systemic risk contribution of 3,500 Money Market Funds (MMFs) in normal periods and during asset price bubbles in the US from January 2004 to December 2022. Using state-of-the-art statistical techniques for bubble detection and granular fund-level data, we show that MMF characteristics significantly influence systemic risk. Large MMFs and government MMFs, which invest exclusively in US Treasury securities, are associated with reduced systemic risk, while prime MMFs contribute to higher systemic risk. MMFs denominated in US dollars but domiciled offshore exhibit no significant differences from their US-domiciled counterparts.
JEL classification: C23, G21, G15
Keywords: financial crises, financial bubbles, backward supremum augmented Dickey-Fuller test, systemic risk measures, panel data
