Liquidity Risk and Limited Arbitrage: Are Taxpayers Helping Hedge Funds Get Rich?

Journal of Investment Management, Second Quarter, 2009

Posted: 17 Jul 2009 Last revised: 10 Nov 2009

Date Written: July 17, 2009

Abstract

Hedge funds facing capital constraints during market-wide liquidity shocks use bank credit lines to reduce the limits to arbitrage. During shocks, government-protected bank deposits receive inflows and this exclusive low cost funding enables banks to lend to hedge funds. In effect, banks compete away the government subsidy while tax-avoiding hedge funds reap the lion share of the benefits. After the advent of hedge funds, the existing government safety net protecting banks is no longer optimal in the sense of maximizing social surplus.

Keywords: Value spread, value premium, market timing, Asia

JEL Classification: G00

Suggested Citation

Gatev, Evan, Liquidity Risk and Limited Arbitrage: Are Taxpayers Helping Hedge Funds Get Rich? (July 17, 2009). Journal of Investment Management, Second Quarter, 2009, Available at SSRN: https://ssrn.com/abstract=1435457

Evan Gatev (Contact Author)

Simon Fraser University ( email )

Burnaby, British Columbia V5A 1S6
Canada

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