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Hedge Funds as Liquidity Providers: Evidence from the Lehman Bankruptcy

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  • George O. Aragon
  • Philip E. Strahan
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    Abstract

    Using the September 15, 2008 bankruptcy of Lehman Brothers as an exogenous shock to funding costs, we show that hedge funds act as liquidity providers. Hedge funds using Lehman as prime broker could not trade after the bankruptcy, and these funds failed twice as often as otherwise-similar funds after September 15 (but not before). Stocks traded by the Lehman-connected hedge funds in turn experienced greater declines in market liquidity following the bankruptcy than other stocks; and, the effect was larger for ex ante illiquid stocks. We conclude that shocks to traders’ funding liquidity reduce the market liquidity of the assets that they trade.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15336.

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    Date of creation: Sep 2009
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    Publication status: published as H EDGE F UNDS AS L IQUIDITY P ROVIDERS : E VIDENCE FROM THE L EHMAN B ANKRUPTCY , 2012, Journal of Financial Economics 103(3), 570-87, with George O. Aragon.
    Handle: RePEc:nbr:nberwo:15336

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    1. Tarun Chordia, 2001. "Market Liquidity and Trading Activity," Journal of Finance, American Finance Association, vol. 56(2), pages 501-530, 04.
    2. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
    3. Lasse Heje Pederson & Markus K Brunnermeier, 2007. "Market Liquidity and Funding Liquidity," FMG Discussion Papers dp580, Financial Markets Group.
    4. Pástor, Luboš & Stambaugh, Robert F, 2002. "Liquidity Risk and Expected Stock Returns," CEPR Discussion Papers 3494, C.E.P.R. Discussion Papers.
    5. Acharya, Viral V & Pedersen, Lasse Heje, 2004. "Asset Pricing with Liquidity Risk," CEPR Discussion Papers 4718, C.E.P.R. Discussion Papers.
    6. Glosten, Lawrence R. & Harris, Lawrence E., 1988. "Estimating the components of the bid/ask spread," Journal of Financial Economics, Elsevier, vol. 21(1), pages 123-142, May.
    7. Darwin Choi & Mila Getmansky & Brian Henderson & Heather Tookes, 2009. "Convertible Bond Arbitrageurs as Suppliers of Capital," Yale School of Management Working Papers amz2365, Yale School of Management, revised 08 Dec 2009.
    8. Brennan, Michael J. & Subrahmanyam, Avanidhar, 1996. "Market microstructure and asset pricing: On the compensation for illiquidity in stock returns," Journal of Financial Economics, Elsevier, vol. 41(3), pages 441-464, July.
    9. Markus K. Brunnermeier & Stefan Nagel, 2004. "Hedge Funds and the Technology Bubble," Journal of Finance, American Finance Association, vol. 59(5), pages 2013-2040, October.
    10. Lee, Charles M C & Ready, Mark J, 1991. " Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-46, June.
    11. James Aitken & Manmohan Singh, 2009. "Deleveraging After Lehman," IMF Working Papers 09/42, International Monetary Fund.
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    Cited by:
    1. Longstaff, Francis A., 2010. "The subprime credit crisis and contagion in financial markets," Journal of Financial Economics, Elsevier, vol. 97(3), pages 436-450, September.

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