Abstract: We examine the trading activity of institutional investors when mega hedge funds (MHFs) experience financial distress. Stocks that are anticipated to be sold by distressed MHFs next quarter experience greater selling by other institutions and elevated short interest in the current quarter. Using downloads of 13F filings to proxy for exposure to anticipatory trading, we find that more exposed distressed MHFs subsequently experience 2.21% lower style-adjusted returns. Stocks that are anticipated to be sold by distressed MHFs experience negative abnormal returns and subsequent return reversals. We conclude that institutions trade ahead of distressed MHFs and destabilize stock prices.
Discussant: Bing Liang, University of Massachusetts-Amherst
Lubomir Petrasek, Federal Reserve Board of Governors
Dan Li, Federal Reserve Board of Governors
Mary Tian, Federal Reserve Board of Governors
Abstract: Self-imposed risk limits effectively limit dealers' appetite for risks and their capacity to intermediate in Treasury markets in times of market stress. Using granular and high frequency regulatory data on US dealers' Treasury securities trading desk positions and desk-level Value-at-Risk limits, we show that dealers are more inclined to reduce their positions as they get closer to their internal risk limit, consistent with such limit being meaningful and costly for traders to breach. Dealers actively manage their inventories away from their limits by selling longer-term securities and requiring higher compensation to take on additional risks. During the height of the Covid-crisis in 2020, dealer desks that were closer to their VaR limits sold more Treasury securities to the Fed and accepted lower prices in the emergency open market operations. Our findings complement studies that link post-GFC bank regulations to market liquidity by showing that self-imposed risk limits can explain the risk-averse behavior by dealers, and offers a micro-foundation for the link between market volatility and market liquidity in dealer-intermediated OTC markets. Policy prescriptions such as deregulation alone may not be sufficient to induce risk-taking by dealer intermediaries in times of crisis.
Discussant: Sebastien Plante, University of Wisconsin-Madison
Abstract: Pension funds rely on interest rate swaps to hedge the interest rate risk arising from their liabilities. Analyzing unique data on Dutch pension funds, we show that this hedging behavior exposes pension funds to liquidity risk due to margin calls, which can be as large as 15% of their total assets. Our analysis uncovers three key findings: (i) pension funds with tighter regulatory constraints use swaps more aggressively; (ii) in response to rising interest rates, triggering margin calls, pension funds predominantly sell safe and short-term government bonds; (iii) we demonstrate that this procyclical selling adversely affects the prices of these bonds.
Discussant: Pouya Behmaram, University of Quebec at Montreal
