Assessing the credit risk of money market funds during the eurozone crisis

• We study credit risks in prime money market funds (MMFs) through the eurozone crisis.
• We calculate the insurance premium needed to protect a fund from “breaking the buck.”
• The credit risk of MMFs doubled, on average, from June to December 2011.
• This increase reflected contagion in the worldwide banking system.
• The SEC's 2010 reforms likely improved the ability of MMFs to withstand credit shocks.

This paper measures credit risk in prime money market funds (MMFs) and studies how such credit risk evolved during the eurozone crisis of 2011–2012. To accomplish this, we estimate the annualized expected loss on each fund's portfolio. We also calculate by Monte Carlo the cost of insuring a fund against losses amounting to over 50 basis points. We find that credit risk of prime MMFs, though small, doubled from 12 basis points in June 2011 to 23 basis points in 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. We conclude that the increase in the credit risk of prime MMFs in the second half of 2011 reflected contagion in the worldwide banking system coupled with slowing global economic growth, not actions taken by MMFs.