Quid Pro Quo: Liquidity Insurance in Dealer-Fund Network
62 Pages Posted: 11 Dec 2020
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: Suggested Citation