What Constrains Liquidity Provision? Evidence from Hedge Fund Trades

46 Pages Posted: 9 Apr 2019

See all articles by Francesco A. Franzoni

Francesco A. Franzoni

Universita della Svizzera italiana (USI Lugano); Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

Alberto Plazzi

Universita' della Svizzera italiana; Swiss Finance Institute

Efe Cotelioglu

American University of Sharjah

Multiple version iconThere are 3 versions of this paper

Date Written: April 2019

Abstract

The paper investigates the determinants of limits of arbitrage for liquidity providers. Using data on institutional transactions, we find that hedge funds' liquidity provision is more exposed to financial conditions than that of other institutions, notably mutual funds. We identify leverage, age, asset illiquidity, and reputational capital as a relevant set of characteristics that explain the exposure of hedge funds' liquidity supply to funding conditions. Stocks with more exposure to constrained liquidity providing hedge funds suffered more during the financial crisis. Finally, we find that the trades of financially constrained hedge funds underperform for at least one quarter following negative funding shocks.

Keywords: funding liquidity, Hedge Funds, Limits of arbitrage, Liquidity Provision, Trading Costs

JEL Classification: G20, G23

Suggested Citation

Franzoni, Francesco A. and Plazzi, Alberto and Cotelioglu, Efe, What Constrains Liquidity Provision? Evidence from Hedge Fund Trades (April 2019). CEPR Discussion Paper No. DP13645, Available at SSRN: https://ssrn.com/abstract=3368142

Francesco A. Franzoni

Universita della Svizzera italiana (USI Lugano) ( email )

Swiss Finance Institute ( email )

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

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Alberto Plazzi

Universita' della Svizzera italiana ( email )

Via Buffi 13
CH-6900 Lugano
Switzerland

HOME PAGE: http://usi.to/mpy

Swiss Finance Institute ( email )

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

Efe Cotelioglu (Contact Author)

American University of Sharjah ( email )

P.O. Box 26666
Sharjah
United Arab Emirates

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