Assessing Credit Risk in Money Market Fund Portfolios
Investment Company Institute - Research
Paris School of Economics (PSE), Centre d'Economie de la Sorbonne
May 27, 2014
Abstract: This paper measures credit risk in prime money market funds (MMFs), studies how such credit risk evolved in 2011-2012, and tests the efficacy of the Securities and Exchange Commission’s (SEC) January 2010 reforms, which were designed to improve the ability of MMFs to withstand severe market stresses. To accomplish this, we create a measure called “expected loss-to-maturity” or ELM. This is an estimate of the credit default swap premium (CDS) needed to insure the fund’s portfolio against credit losses. We also calculate by Monte Carlo the cost of insuring a fund against losses amounting to over 50 basis points. We find that ELM for prime MMFs was 15 basis points on an asset-weighted average basis over 2011-2012. Credit risk of prime MMFs rose from June to December 2011 before receding in 2012. Contrary to common perceptions, this did not primarily reflect funds’ credit exposure to eurozone banks because funds took measures to reduce this exposure. Instead, credit risk in prime MMFs rose because of the deteriorating credit outlook of banks in the Asia/Pacific region. Finally, we find evidence that the SEC’s 2010 liquidity and weighted average life (WAL) requirements reduced the credit risk of prime MMFs.