Liquidity Provision in a One-Sided Market: The Role of Dealer-Hedge Fund Relations

Abstract

We show that dealers' prime brokerage relations with certain hedge funds help improve their liquidity provision in a one-sided market. During the March 2020 liquidity crisis, hedge funds increased their corporate bond positions when the bond market faced excessive selling pressures. Dealers connected with hedge funds that are natural buyers of corporate bonds charged lower transaction costs on heavily sold bonds. Dealers' leverage and funding constraints do not explain our results, nor do connections with hedge funds that are natural buyers of other asset classes. Our findings reveal that dealers' willingness to provide liquidity in a one-sided market depends on their connections with natural buyers of corporate bonds.

Keywords: JEL classification: G12, G23, G24 broker-dealers, hedge funds, corporate bonds, market liquidity

JEL Classification: G12, G23, G24.