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

Authors

Mathias S. Kruttli, Indiana University - Kelley School of BusinessFollow
Marco Macchiavelli, Isenberg School of ManagementFollow
Phillip Monin, Board of Governors of the Federal Reserve SystemFollow
Xing (Alex) Zhou, Southern Methodist University (SMU) - Finance DepartmentFollow

Publication Date

5-14-2025

Abstract

During the bond market liquidity crisis of March 2020, dealers connected with corporate bond trading hedge funds charged lower transaction costs on bonds subject to mutual fund fire sales. This effect was particularly strong in bonds with limited alternative buyers, such as insurance companies. Further, dealers with stronger hedge fund connections committed less capital to inventories. Despite selling equities and U.S. Treasuries, hedge funds purchased corporate bonds in March 2020, partly due to the widening CDS-bond basis. Our findings suggest that hedge fund connections help dealers overcome search frictions and increase their willingness to provide liquidity in a one-sided market.

Document Type

Article

Keywords

hedge funds, corporate bonds, market liquidity, mutual funds, fire sales, insurance firms, broker-dealers

Disciplines

Finance

DOI

10.2139/ssrn.4662272

Source

SMU Cox: Finance (Topic)

Language

English