Does Funding Liquidity Cause Market Liquidity? Evidence from a Quasi-Experiment

38 Pages Posted: 27 Aug 2015 Last revised: 23 May 2018

Date Written: May 21, 2018

Abstract

Using an exogenous reduction in margin requirements, this paper shows that funding liquidity causally affects market liquidity. On July 14, 2005 the Securities and Exchange Commission approved a pilot program that permitted portfolio margining of index options but not equity options. The resulting significant improvement of funding liquidity leads to an increase in trading volume, a decrease bid-ask spread, and a decrease in price impact for index options compared to the unaffected equity options. These results provide strong causal evidence in support of the theories presented by Gromb and Vayanos (2002) and Brunnermeier and Pedersen (2009).

Keywords: Funding liquidity, market liquidity, portfolio margin

JEL Classification: G12, G28

Suggested Citation

Jylha, Petri, Does Funding Liquidity Cause Market Liquidity? Evidence from a Quasi-Experiment (May 21, 2018). Available at SSRN: https://ssrn.com/abstract=2651088 or http://dx.doi.org/10.2139/ssrn.2651088

Petri Jylha (Contact Author)

Aalto University ( email )

P.O. Box 21220
Aalto, 00076
Finland

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