Abstract
We measure the reaction of search for income in mutual funds to supervisory-induced dividend restrictions on euro area banks during the COVID-19 pandemic, which operated as an exogenous shock to payouts in this sector. Using granular data on euro area-based mutual funds’ holdings, we show that demand for dividends motivated portfolio decisions in this period and that these decisions had implications for stock returns. Specifically, we document that there were more sales of bank stocks by income-oriented funds after payout restrictions were set in place. These funds were however less inclined to dispose of bank CoCos, an alternative high income-generating asset issued by credit institutions and not subject to supervisory distribution limits. Lastly, we analyze the price impact of these portfolio adjustments, documenting negative abnormal returns in bank stocks more exposed to income-oriented funds after the policy announcement. Our research evidences that search for income is relevant in asset allocation decisions and price formation, and quantifies some of the side effects of dividend restriction policies.