Showing papers on "Funding liquidity published in 2021"
TL;DR: Long-term reversals in corporate bonds are economically and statistically significant in a comprehensive sample spanning the period 1977 to 2017 as mentioned in this paper, and such reversals are stronger for bonds with high credit risk and more binding regulatory, capital, and funding liquidity constraints.
31 citations
TL;DR: In this article, the authors use the advent of new credit default swap (CDS) trading conventions in April 2009, the CDS Big Bang, to study how a shock to funding liquidity impacts market liquidity.
13 citations
TL;DR: In this paper, the authors identify economic transmission channels through which changes in funding liquidity conditions in interbank markets asymmetrically affect volatilities of stock portfolios during the COVID-19 crisis.
Abstract: In this study, we identify economic transmission channels through which changes in funding liquidity conditions in interbank markets asymmetrically affect volatilities of stock portfolios during the COVID-19 crisis. For the purpose of this study, the quantile regression approach is utilized. Controlling for macroeconomic factors, we document that volatilities of high-risk portfolios increase more in response to a deterioration in funding liquidity conditions compared to less risky portfolios. More importantly, this increase intensifies in high-volatility periods of high-risk portfolios, which implies the impact is stronger during uncertain economic environments, such as the one caused by the COVID-19 outbreak.
9 citations
9 citations
TL;DR: In this article, the authors show that a sudden increase in margin requirements during the COVID-19 pandemic is correlated with the withdrawal of global liquidity providers, consistent with the binding nature of increased capital constraints.
8 citations
TL;DR: The authors disentangle asset-specific, market, and funding liquidity in the CDS-Bond basis outside and during the 07/09 Global Financial Crisis and stress the importance of separating different types of liquidity, since all three measures have independently negative impacts on the basis.
Abstract: We disentangle asset-specific, market, and funding liquidity in the CDS-Bond basis outside and during the 07/09 Global Financial Crisis Our findings stress the importance of separating different types of liquidity, since all three measures have independently negative impacts on the basis Funding liquidity emerges as the economically most important liquidity metric While asset-specific liquidity is cross-correlated in both the cash and derivative markets, funding and market liquidity only matter for the cash market We exploit the decomposition of the basis to test predictions of limits-to-arbitrage theories We find strong evidence in favor of margin-based asset pricing and flight-to-quality effects This article is protected by copyright All rights reserved
8 citations
21 Jun 2021
TL;DR: In this article, the authors investigate the impact of funding liquidity risk on the banks' risk-taking behavior and find that increases in bank funding liquidity increase both risk-weighted assets and liquidity creation, and deposit insurance creates a moral risk issue for banks taking excessive risks in response to deposit rises.
Abstract: The purpose of this study is to investigate the impact of funding liquidity risk on the banks’ risk-taking behavior. To test the hypotheses, we apply the two-step system GMM technique on US commercial banks data from 2002 to 2018. We find that funding liquidity increases the banks’ risk-taking of US commercial banks. Furthermore, banks with higher deposits are less likely to face a funding shortage, and bank managers’ aggressive risk-taking activity is less likely to be monitored. Our findings infer that increases in bank funding liquidity increase both risk-weighted assets and liquidity creation, and deposit insurance creates a moral risk issue for banks taking excessive risks in response to deposit rises. The relationship between funding liquidity and the banks’ risk-taking varies with their capitalization and market conditions; the impact of funding liquidity on risk-taking is pronounced for well-capitalized banks and the Global Financial Crisis 2007. Our tests are robust for the usage of alternate proxy of funding liquidity and by controlling economic conditions. The findings of this study have implications for regulators to develop guidelines for the level of liquidity and risk-taking of commercial banks.
8 citations
TL;DR: In this article, the authors provide direct evidence of how dealers' funding liquidity affects their liquidity provision in securities markets, showing that worse funding liquidity (higher repo haircuts and rates) leads to larger bid-as-as...
Abstract: We provide direct evidence of how dealers’ funding liquidity affects their liquidity provision in securities markets. Worse funding liquidity (higher repo haircuts and rates) leads to larger bid-as...
7 citations
TL;DR: In this paper, the authors present new evidence on the effect of funding liquidity on market liquidity and find no evidence that lower short-term interest rates, the key instruments of monetary policy, boost market liquidity.
Abstract: Using a comprehensive dataset of orders and trades in the Indian government bond market, this study presents new evidence on the effect of funding liquidity on market liquidity. We find no evidence that lower short-term interest rates – the key instruments of monetary policy – boost market liquidity. However, consistent with models that stress the role of intermediary capital, we find that market liquidity measures have a strong, positive association with short-term borrowing by primary dealers. We provide additional evidence linking these firms’ borrowing to their balance sheet strength and secondary market participation. The results suggest that localized funding conditions specific to marginal suppliers of intermediation services are more important for market liquidity than the broader economy-wide funding environment.
6 citations
TL;DR: In this paper, fund families use closed-end funds to provide liquidity to distressed open-end fund by coordinating cross-trading through the internal markets, which improves the performance of open end funds receiving the liquidity provision.
Abstract: The high flow-performance sensitivity of open-end municipal bond funds motivates fund managers to actively manage funding liquidity risk and reduce the costs of flow-driven transactions. We show that fund families use closed-end funds to provide liquidity to distressed open-end funds by coordinating cross-trading through the internal markets. Larger national funds, funds with lower cash holdings, and fund families with more flexible agency cross-trading policies engage more in liquidity-driven cross-trading. Such cross-trading improves the performance of open-end funds receiving the liquidity provision. Consistent with cross-fund subsidization and family-value maximization, fund families tend to engage low-value closed-end funds in cross-trading for liquidity management.
5 citations
TL;DR: In this article, a search-theoretic model of bond and CDS markets is proposed, which features endogenous funding liquidity and interdependent bond-and CDS market liquidity, and the implications from the long and short-run effects help rationalize the observed changes in bond market liquidity.
Abstract: This paper builds a search-theoretic model of bond and CDS markets that features endogenous funding liquidity and interdependent bond and CDS market liquidity. I show that, in the long run, speculative CDS trades attract liquidity into the CDS market than then, due to search frictions, spills over into the bond market and increases bond market liquidity. In the short run, however, speculative CDS buyers instead attract liquidity away from the bond market. In a separate empirical paper, I document how a series of European policies that banned speculative CDS purchases affected bond market liquidity. The implications from the longand short-run effects help rationalize the observed changes in bond market liquidity.
TL;DR: In this article, the expiring nature of hedge fund lockups is exploited to create a new measure of funding liquidity risk that varies within funds, and hedge funds with lower funding risk generate higher returns, and this effect is driven by their increased exposure to equity-mispricing anomalies.
Abstract: We exploit the expiring nature of hedge fund lockups to create a new measure of funding liquidity risk that varies within funds. We find that hedge funds with lower funding risk generate higher returns, and this effect is driven by their increased exposure to equity-mispricing anomalies. Our results are robust to a variety of sampling criteria, variable definitions, and control variables. Further, we address endogeneity concerns in various ways, including a placebo approach and regression discontinuity design. Collectively, our results support a causal link between funding risk and the ability of managers to engage in risky arbitrage.
TL;DR: In this paper, the authors construct novel measures of gross and net short covering to examine when short sellers exit their positions and find that idiosyncratic limits to arbitrage, such as adverse stock price movements, volatility, and equity lending fees are associated with significantly higher position closures and lower price efficiency.
Abstract: We construct novel measures of gross and net short covering to examine when short sellers exit their positions. We find that idiosyncratic limits to arbitrage, such as adverse stock price movements, volatility, and equity lending fees are associated with significantly higher position closures and lower price efficiency. Moreover, these position closures predict future return movements in the wrong direction, suggesting short sellers may be induced to exit too early. In contrast, we find little evidence that aggregate limits to arbitrage including VIX, funding liquidity, and market volatility affect gross or net short covering. The results show that firm-level limits to arbitrage are important determinants of trading behavior.
TL;DR: In this article, the authors investigate the time-varying relationship of funding liquidity (FL) and market liquidity (ML) in a Markov regime-switching model and find that FL and ML exhibit a large and positive mutual impact when money market is tight and equity market is volatile.
Abstract: We investigate the time‐varying relationship of funding liquidity (FL) and market liquidity (ML) in a Markov regime‐switching model. By using a comprehensive U.S. TRACE dataset, we provide strong evidence that FL and corporate bond ML are interlinked, and their impact on each other is highly regime‐dependent. We find that FL and ML exhibit a large‐and‐positive mutual impact when money market is tight and equity market is volatile. But in normal regimes, FL is found to have a negative impact on ML with a much smaller magnitude than those in stressed regimes. Furthermore, FL is more stable than ML with less regime changes. Our article offers insight on the important mechanism by which central banks can improve ML through the funding market.
TL;DR: In this article, the authors construct a measure of mismatch between the market liquidity of assets and the funding liquidity of liabilities of hedge funds, which captures the complete liquidity landscape of hedge hedge funds by encompassing liquidity from both sides of the balance sheet.
Abstract: The authors construct a comprehensive measure of mismatch between the market liquidity of assets and the funding liquidity of liabilities of hedge funds. The measure captures the complete liquidity landscape of hedge funds by encompassing liquidity from both sides of the balance sheet. Using quarterly Form Private Fund (PF) filings, they use portfolio, investor, and financing illiquidity to construct the liquidity mismatch measure and study its dynamics from 2013–2015. They find that the market liquidity of a hedge fund’s assets is typically higher than the funding liquidity of its borrowings and investor capital (negative liquidity mismatch). However, liquidity mismatch tends to be greater (more positive) when VIX is high and among funds with higher leverage, lower managerial stake, and smaller size. TOPICS:Real assets/alternative investments/private equity, risk management, exchanges/markets/clearinghouses, financial crises and financial market history Key Findings ▪ The authors use a unique Form PF dataset with information on portfolio, investor, and financial illiquidity to construct a comprehensive measure of mismatch between the market liquidity of assets and the funding liquidity of liabilities of hedge funds. ▪ The authors find that the market liquidity of a hedge fund’s assets is typically higher than the funding illiquidity of its borrowings and investor capital (negative liquidity mismatch). ▪ However, liquidity mismatch tends to be greater (more positive) when VIX is high and among funds with higher leverage, lower managerial stake, and smaller size.
TL;DR: In this article, the authors observe that central bank policies may trigger credit rationing and borrowing cost increases, resulting in contemporaneous institutional lenders and market makers funding illiquidity, and in turn, this funding is transmitted through banks and broker/dealers to market illiquidities of individual stocks.
Abstract: We observe, especially during financial crisis periods, that central bank policies may trigger credit rationing and borrowing cost increases, resulting in contemporaneous institutional lender and market maker funding illiquidity. In turn, funding illiquidity is transmitted through banks and broker/dealers to market illiquidity of individual stocks. Thus, funding illiquidity, often originating with central bank monetary policy, is contemporaneously conveyed through institutional lenders, transferred to broker/dealers and spawns interconnected stock market illiquidity spirals and loss spirals. Our results are consistent and robust across different models that control for endogenous and exogenous factors.
TL;DR: This article developed Residual MisPricing (RMP), an index capturing mispricing relative to a linear benchmark asset pricing model, from the structure imposed by no-arbitrage.
Abstract: We develop Residual MisPricing (RMP), an index capturing mispricing relative to a linear benchmark asset pricing model, from the structure imposed by no-arbitrage. RMP is fully conditional and depends only on the returns of basic assets. Return data for several economies reveal that RMP is countercyclical and related to financial uncertainty. RMP further shows a strong positive relation to conditional international equity and currency risk premia, as well as a close link to market-wide funding liquidity shocks. The relations we document hold in particular out-of-sample. Our evidence points to new record highs for RMP during the COVID-19 era, similar to its behavior in the 2008 financial crisis.
TL;DR: In this paper, the authors study the relationship between funding liquidity and the valuation of mortgage-backed securities and develop a new model-implied measure of funding liquidity of MBS investors that is independent of prepayment risk premia and agency credit spreads.
Abstract: We study the relationship between funding liquidity and the valuation of mortgage-backed securities. Most of the financing for mortgage-backed securities occurs through a trade known as a dollar roll, the simultaneous sale and purchase of forward contracts on mortgage-backed securities that is analogous to a repurchase agreement. We develop a four-factor no-arbitrage model for valuing mortgage-backed securities that allows for the valuation of dollar rolls. Unlike previous models of the dollar roll, we allow for the possibility of a prepayment risk premium. We develop a new model-implied measure of funding liquidity of MBS investors that is independent of prepayment risk premia and agency credit spreads. We find that our implied funding liquidity spread is strongly related to measures of intermediary balance sheet constraints and primary dealer positions in mortgage-backed securities.
TL;DR: In this article, the interactions between funding liquidity and market volatility on the equity market are investigated. But the literature examines the interactions among funding liquidity, market volatility, and volatility in the stock market.
Abstract: The extant literature examines the interactions between funding liquidity and market volatility on the equity market. This paper extends the literature and investigates the interactions between fun...
TL;DR: In this paper, the authors examined whether the differences in accounting information between stocks affect cross-asset return predictability and found that abnormal accruals, earnings smoothness, book-to-market, firm age, leverage, abnormal capital investment and investment growth, among others, explain the variation in return predictivity across pairing stocks.
Abstract: This paper examines whether the differences in accounting information between stocks affect cross‐asset return predictability. We use a comprehensive set of accounting variables and find that abnormal accruals, earnings smoothness, book‐to‐market, firm age, leverage, abnormal capital investment and investment growth, among others, explain the variation in return predictability across pairing stocks. Moreover, our results show that cross‐asset predictability varies over time and is associated with funding liquidity and market sentiment. A simple trading strategy based on our findings yields a higher mean return, lower standard deviation and higher Sharpe ratio compared to a buy‐and‐hold strategy.
TL;DR: In this article, the joint impact of bank capital and deposits on the latter remains poorly documented, and a tradeoff arises between financial stability and increased funding liquidity for these financial intermediaries, making a special treatment required for inefficient banks operating in a low interest rate environment.
Abstract: Despite an extensive literature on the risk–taking channel of monetary policy, the joint impact of bank capital and deposits on the latter remains poorly documented. Yet that prospect is essential for monetary policy taking action under the Basel III framework involving concomitant capital and funding liquidity standards. Using data on euro area from 1999 to 2018 and triple interactions between monetary policy, equity and funding liquidity, we shed light on a "crowding–out of deposits" effect prior to the 2008 GFC which supports the need for simultaneous capital and funding liquidity ratios to mitigate the monetary transmission to bank credit risk. Interestingly, our findings also highlight a missing "crowding–out of deposits" effect amongst poorly efficient banks in the aftermath of the GFC. As a result, a trade-off arises between financial stability and increased funding liquidity for these financial intermediaries, making a special treatment required for inefficient banks operating in a low interest rate environment. These results challenge the implementation of uniform funding liquidity requirements across the euro area.
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TL;DR: In this paper, the authors investigate the transmission of funding liquidity shocks, credit risk shocks and unconventional monetary policy within the Euro area by estimating a financial GVAR model for Germany, France, Italy and Spain over the period 2006-2017.
Abstract: This paper investigates the transmission of funding liquidity shocks, credit risk shocks and unconventional monetary policy within the Euro area. To this aim, a financial GVAR model is estimated for Germany, France, Italy and Spain on monthly data over the period 2006-2017. The interactions between repo markets, sovereign bonds and banks' CDS spreads are analyzed, explicitly accounting for the country-specific effects of the ECB's asset purchase programmes. Impulse response analysis signals core-periphery heterogeneity and persistent flight to quality. A simulated reduction in any ECB programme ultimately results in rising yields and bank CDS spreads in Italy and Spain, as well as in falling repo trade volumes and rising repo rates in all four countries.
TL;DR: The authors examined the characteristics of U.S. firms with cross-listed shares in 20 foreign markets in the 1950-2013 period and found that firms after foreign-market listing exhibit lower liquidity sensitivity and lower liquidity beta and suffer less from transitory price shocks.
Abstract: We examine liquidity-related characteristics of U.S. firms with cross-listed shares in 20 foreign markets in the 1950–2013 period. We find that firms after foreign-market listing exhibit lower liquidity sensitivity and lower liquidity beta and suffer less from transitory price shocks. These results are stronger when firms are listed on multiple exchanges and in larger and more liquid markets. The liquidity enhancement is associated with firms’ increased foreign ownership postlisting and is effective for firms with high levels of volatility, foreign income, and foreign trading and a high probability of informed trading. Our findings provide support for global markets providing liquidity and reducing liquidity risk to U.S. firms.
TL;DR: In this article, a positive cross-sectional relation between returns and lagged idiosyncratic volatility (IVOL) in the corporate bond market is investigated. But the relation is stronger following periods of low funding liquidity due to a funding liquidity driven decrease in returns and its subsequent reversal.
Abstract: This paper documents a positive cross-sectional relation between returns and lagged idiosyncratic volatility (IVOL) in the corporate bond market. The relation is stronger following periods of low funding liquidity due to a funding liquidity driven decrease in returns and its subsequent reversal. Three exogenous shocks – (i) the Volcker Rule which restricted the participation of dealers in the corporate bond market in 2014, (ii) the Global Financial Crisis of 2008, and (iii) the COVID-19 crisis of 2020, are used to establish causality between funding liquidity and the positive IVOL-return relation.
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TL;DR: In this paper, the authors proposed a methodological and practical framework in order to perform liquidity stress testing programs, which comply with regulatory guidelines (ESMA, 2019, 2020) and are useful for fund managers.
Abstract: This article is part of a comprehensive research project on liquidity risk in asset management, which can be divided into three dimensions. The first dimension covers the modeling of the liability liquidity risk (or funding liquidity), the second dimension is dedicated to the modeling of the asset liquidity risk (or market liquidity), whereas the third dimension considers the management of the asset-liability liquidity risk (or asset-liability matching). The purpose of this research is to propose a methodological and practical framework in order to perform liquidity stress testing programs, which comply with regulatory guidelines (ESMA, 2019, 2020) and are useful for fund managers. In this third and last research paper focused on managing the asset-liability liquidity risk, we explore the ALM tools that can be put in place to control the liquidity gap. These ALM tools can be split into three categories: measurement tools, management tools and monitoring tools. In terms of measurement tools, we focus on the computation of the redemption coverage ratio (RCR), which is the central instrument of liquidity stress testing programs. We also study the redemption liquidation policy and the different implementation methodologies, and we show how reverse stress testing can be developed. In terms of liquidity management tools, we study the calibration of liquidity buffers, the pros and cons of special arrangements (redemption suspensions, gates, side pockets and in-kind redemptions) and the effectiveness of swing pricing. In terms of liquidity monitoring tools, we compare the macro- and micro-approaches of liquidity monitoring in order to identify the transmission channels of liquidity risk.
TL;DR: In this article, the authors proposed a framework to perform liquidity stress testing programs, which comply with regulatory guidelines (ESMA, 2019, 2020) and are useful for fund managers.
Abstract: This article is part of a comprehensive research project on liquidity risk in asset management, which can be divided into three dimensions. The first dimension covers liability liquidity risk (or funding liquidity) modeling, the second dimension focuses on asset liquidity risk (or market liquidity) modeling, and the third dimension considers the asset-liability management of the liquidity gap risk (or asset-liability matching). The purpose of this research is to propose a methodological and practical framework in order to perform liquidity stress testing programs, which comply with regulatory guidelines (ESMA, 2019, 2020) and are useful for fund managers. The review of the academic literature and professional research studies shows that there is a lack of standardized and analytical models. The aim of this research project is then to fill the gap with the goal of developing mathematical and statistical approaches, and providing appropriate answers. In this second article focused on asset liquidity risk modeling, we propose a market impact model to estimate transaction costs. After presenting a toy model that helps to understand the main concepts of asset liquidity, we consider a two-regime model, which is based on the power-law property of price impact. Then, we define several asset liquidity measures such as liquidity cost, liquidation ratio and shortfall or time to liquidation in order to assess the different dimensions of asset liquidity. Finally, we apply this asset liquidity framework to stocks and bonds and discuss the issues of calibrating the transaction cost model.