N°23-42: Passive Demand and Active Supply: Evidence from Maturity-Mandated Corporate Bond Funds

We identify a novel and common exogenous demand shock caused by passive funds in the corporate bond market. Specifically, passive fund demand for corporate bonds displays discontinuity around the maturity cutoffs separating long-term, intermediate-term, and short-term bonds. Passive funds' demand increases significantly upon a bond's crossing of 10-, 5-, and 3-year time-to-maturity cutoffs. We develop a novel identification strategy to study the impact of passive fund demand in the corporate bond market. First, we find that these non-fundamental demand shifts lead to a significant and lasting decrease in yield spreads, as well as persistent liquidity improvements. Second, we find that passive fund demand shocks spill over to the primary market, causing lower issuing yield spreads and actively higher net debt issuance, thereby impacting firms' financing and investment activities.