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

Using a novel approach based on hurricanes, this paper contributes to the recent debate on whether nonfundamental price variations affect real economic activities. Hurricanes create liquidity demand from investors living in disaster zones. This translates into additional outflows for mutual funds in the areas affected by hur- ricanes of about $2.5 billions. Such outflows cause fire sales, which are followed by temporary price drops in stocks unrelated to the natural disaster (-7% reverted within 10 months). The nonfundamental price decline 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 variations actually distort firms’ real decisions