What Constrains Liquidity Provision? Evidence From Hedge Fund Trades

45 Pages Posted: 4 Oct 2013 Last revised: 11 Nov 2014

See all articles by Francesco A. Franzoni

Francesco A. Franzoni

USI Lugano; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

Alberto Plazzi

Swiss Finance Institute; USI Lugano

Multiple version iconThere are 3 versions of this paper

Date Written: May 30, 2013

Abstract

The paper investigates the determinants of limits of arbitrage for liquidity providers. Using data on institutional transactions, we compare hedge fund trades to those of other institutions. We find that hedge funds' liquidity supply is more relevant for stock-level liquidity, but it is also more exposed to financial conditions than that of other institutions. We identify leverage, low redemptions restrictions, asset illiquidity, and reputational capital as a sufficient set of characteristics that explain the exposure of hedge funds' liquidity supply to funding conditions. Finally, we find that the trades of financially constrained hedge funds underperform for at least one quarter following negative funding shocks.

Keywords: hedge funds, limits of arbitrage, liquidity provision, trading costs, funding liquidity

JEL Classification: G20, G23

Suggested Citation

Franzoni, Francesco A. and Plazzi, Alberto, What Constrains Liquidity Provision? Evidence From Hedge Fund Trades (May 30, 2013). Available at SSRN: https://ssrn.com/abstract=2336051 or http://dx.doi.org/10.2139/ssrn.2336051

Francesco A. Franzoni

USI Lugano ( email )

Via G. Buffi 13
Lugano, 6904
Switzerland

Swiss Finance Institute

Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Alberto Plazzi (Contact Author)

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

USI Lugano ( email )

Via Buffi 13
CH-6900 Lugano
Switzerland

HOME PAGE: http://www.people.usi.ch/plazzia/

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