Swing Pricing Calibration

Calibrating a key component of swing pricing, the swing factor, is difficult, particularly for mutual funds (MFs) that invest substantially in thinly traded debt. We propose a novel way to estimate swing factors by exploiting the structural similarities and differences between MFs and exchange-traded funds (ETFs) with similar underlying portfolios. Our MF liquidity cost is derived as the difference between an ETF’s share price and the value of its underlying assets, conditioned on MF net flows and other factors. We find statistical evidence of substantial ETF discounts associated with MF net outflows during periods of stress; the magnitude of corresponding discounts increases with larger MF net outflows. Thus, our proxy for liquidity costs, ETF discounts, is strongly correlated with MF net outflows during stress, and therefore can be used to approximate MF swing factors. Although we focus on swing pricing, our methodology can also be useful in calibrating other economically equivalent mechanisms, such as redemption fees