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Funding Liquidity and Market Liquidity: The Broker-Dealer Perspective

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  • Marco Macchiavelli

    (Federal Reserve Board, Washington, District of Columbia 20551)

  • Xing (Alex) Zhou

    (Federal Reserve Board, Washington, District of Columbia 20551)

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-ask spreads and transaction costs in corporate bonds. We also find that dealers’ relationships with money funds are important determinants of their repo haircuts and rates. Using dealers’ exposure to the 2016 Securities and Exchange Commission (SEC) money fund reform as an instrument, we show that funding liquidity indeed has a causal effect on market liquidity. Finally, dealers with lower funding liquidity tend to have smaller market shares and execute more trades on an agency basis.

Suggested Citation

  • Marco Macchiavelli & Xing (Alex) Zhou, 2022. "Funding Liquidity and Market Liquidity: The Broker-Dealer Perspective," Management Science, INFORMS, vol. 68(5), pages 3379-3398, May.
    • Handle: RePEc:inm:ormnsc:v:68:y:2022:i:5:p:3379-3398
    DOI: 10.1287/mnsc.2021.4053
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    References listed on IDEAS

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    Cited by:

    1. Ellington, Michael & Kalli, Maria, 2025. "Predictive distributions and the market return: The role of market illiquidity," European Journal of Operational Research, Elsevier, vol. 323(1), pages 309-322.
    2. Hüser, Anne-Caroline & Lepore, Caterina & Veraart, Luitgard Anna Maria, 2024. "How does the repo market behave under stress? Evidence from the COVID-19 crisis," Journal of Financial Stability, Elsevier, vol. 70(C).
    3. Sangyup Choi & Inkee Jang & Kee-Youn Kang & Hyunpyung Kim, 2024. "Haircut, Interest Rate, and Collateral Quality in the Tri-Party Repo Market: Evidence and Theory," Working Papers 11, University of Liverpool, Department of Economics.
    4. Huber, Amy Wang, 2023. "Market power in wholesale funding: A structural perspective from the triparty repo market," Journal of Financial Economics, Elsevier, vol. 149(2), pages 235-259.
    5. Ulrich Krüger & Christoph Roling & Leonid Silbermann & Lui-Hsian Wong, 2025. "Bank’s strategic interaction, adverse price dynamics and systemic liquidity risk," Journal of Banking Regulation, Palgrave Macmillan, vol. 26(1), pages 1-24, March.
    6. Gian Piero Aielli & Davide Pirino, 2023. "Funding Liquidity and Stocks’ Market Liquidity: Structural Estimation From High-Frequency Data," CEIS Research Paper 568, Tor Vergata University, CEIS, revised 28 Nov 2023.

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