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Hedge Funds as Liquidity Providers: Evidence from the Lehman Bankruptcy

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Author Info
George O. Aragon
Philip E. Strahan
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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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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Handle: RePEc:nbr:nberwo:15336

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G2 - Financial Economics - - Financial Institutions and Services
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages

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  1. 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. [Downloadable!] (restricted)
  2. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 111(3), pages 642-685, June. [Downloadable!] (restricted)
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  3. 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. [Downloadable!] (restricted)
  4. James Aitken & Manmohan Singh, 2009. "Deleveraging After Lehman--Evidence from Reduced Rehypothecation," IMF Working Papers 09/42, International Monetary Fund. [Downloadable!]
  5. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 22(6), pages 2201-2238, June. [Downloadable!] (restricted)
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  6. Tarun Chordia, 2001. "Market Liquidity and Trading Activity," Journal of Finance, American Finance Association, vol. 56(2), pages 501-530, 04. [Downloadable!] (restricted)
  7. 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. [Downloadable!] (restricted)
  8. 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. [Downloadable!] (restricted)
  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. [Downloadable!] (restricted)
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