Matching Prime Brokers and Hedge Funds

64 Pages Posted: 7 Nov 2015 Last revised: 6 Dec 2015

See all articles by Egemen Eren

Egemen Eren

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: December 5, 2015

Abstract

Prime brokers and hedge funds form relationships in a matching market. What are the determinants of these matches? How did they change after the financial crisis? I estimate a matching model in which part of the profits of prime brokers and hedge funds depends on variables that are defined at the level of the entire portfolio of clients that a prime broker serves. I show that prime brokers and their client hedge funds choose to have trading relationships with each other in a manner that reflects the benefits of specialization. Moreover, prime brokers preferred risky clients before the crisis, while they were averse to risky clients after the crisis. Identification follows from pairwise matching stability. I analyze the potential underlying economic mechanisms, mainly the cost advantages to a prime broker of collateral re-use between hedge fund clients. This is known as internalization. I estimate that the value of internalization for major prime brokers, such as Goldman Sachs, is around $100-200 million annually.

Keywords: Prime brokers, Hedge funds, Matching, Internalization, Collateral re-use, Financial Networks

JEL Classification: G01, G23, G24, G28, C78

Suggested Citation

Eren, Egemen, Matching Prime Brokers and Hedge Funds (December 5, 2015). Available at SSRN: https://ssrn.com/abstract=2686777 or http://dx.doi.org/10.2139/ssrn.2686777

Egemen Eren (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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