Quid Pro Quo: Liquidity Insurance in Dealer-Fund Network

62 Pages Posted: 11 Dec 2020

See all articles by Luming Chen

Luming Chen

University of California, Irvine - Finance Area

Date Written: November 16, 2020


Using a novel security-level data from SEC on US tri-party repo, this paper investigates how trading relationship impacts liquidity provision within the dealer-fund repo network. This paper documents a unique repo rate dynamic: in normal times, funds charge a premium to dealers with whom they have the strongest trading relationship; in market-wide liquidity shocks, these dealers are rewarded with lower repo rate markup and better immediacy. I exploit the 2016 Money Market Fund Reform as an exogenous liquidity shock to establish a liquidity insurance mechanism. As liquidity insurers are not easily replaceable, shown in the unexpected liquidation case of Charles Schwab Sweep Funds, costly search incentivizes dealers to engage in such stable quid pro quo relationship with money market funds.

Keywords: Over-the-Counter, Trading Network, Money Market Funds Reform, Repo Pricing

JEL Classification: G12, G14, G24

Suggested Citation

Chen, Luming, Quid Pro Quo: Liquidity Insurance in Dealer-Fund Network (November 16, 2020). Available at SSRN: https://ssrn.com/abstract=3731615 or http://dx.doi.org/10.2139/ssrn.3731615

Luming Chen (Contact Author)

University of California, Irvine - Finance Area ( email )

Irvine, CA 92697-3125
United States

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