The Volcker Rule and the Hedge Fund Liquidity Circle
73 Pages Posted: 25 Nov 2019 Last revised: 25 Sep 2022
Date Written: November 13, 2019
Abstract
The implementation of the Volcker Rule (section 619 of the 2010 Dodd-Frank Act)
profoundly impacts the funding liquidity of hedge funds, their liquidity risk exposure
and liquidity provision to the market. Analysing a sample of 5,697 hedge funds, we find that following the legislation, capital flows to hedge funds decline, and their flow-performance sensitivity increases. Hedge funds reduce their market liquidity exposure and realign their market-making activities towards the most liquid stocks. These results support the Brunnermeier-Pedersen model of illiquidity spirals.
Keywords: Volcker Rule, Hedge funds, Liquidity risk, Liquidity provision, Fund flows
JEL Classification: G1, G18, G2, G23, G28
Suggested Citation: Suggested Citation