The Life of the Counterparty: Shock Propagation in Hedge Fund-Prime Broker Credit Networks

Kruttli, Mathias S.; Monin, Phillip; Watugala, Sumudu W.

doi:10.2139/ssrn.3473866

Cited by 3 publications

(2 citation statements)

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“…Our results also do not speak to the potential spillovers to counterparties or the financing liquidity risk that accompany greater leverage. Kruttli, Monin, and Watugala (2019) show that idiosyncratic liquidity shocks to a prime broker can be propagated to the hedge funds to whom it lends. Brunnermeier and Pedersen (2009) show that liquidity spirals can arise when collateral values fall and leveraged investors are forced to sell assets to raise additional capital.…”

Section: Resultsmentioning

confidence: 99%

“…We begin by considering fund size and strategy. Larger funds may benefit from better financing arrangements with their prime brokers, and funds engaged in equities-based strategies likely employ less leverage than funds engaged in relative value trades (Kruttli, Monin, and Watugala (2019)). Column (2) of Table 6 supports the view that larger funds employ more leverage, though size explains only 0.1% of the variation in leverage.…”

Section: The Cross Section Of Hedge Fund Leveragementioning

confidence: 99%

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Leverage and Risk in Hedge Funds

2020

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Section: Resultsmentioning

confidence: 99%

Section: The Cross Section Of Hedge Fund Leveragementioning

confidence: 99%

Leverage and Risk in Hedge Funds

2020

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Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID-19 Crisis

Kruttli

Monin

Petrasek

et al. 2021

FEDS

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Hedge fund gross U.S. Treasury (UST) exposures doubled from 2018 to February 2020 to $2.4 trillion, primarily driven by relative value arbitrage trading and supported by corresponding increases in repo borrowing. In March 2020, amid unprecedented UST market turmoil, the average UST trading hedge fund had a return of -7% and reduced its UST exposure by close to 20%, despite relatively unchanged bilateral repo volumes and haircuts. Analyzing hedge fund-creditor borrowing data, we find the large, more regulated dealers provided disproportionately more funding during the crisis than other creditors. Overall, the step back in hedge fund UST activity was primarily driven by fund-specific liquidity management rather than dealer regulatory constraints. Hedge funds exited the turmoil with 20% higher cash holdings and smaller, more liquid portfolios, despite low contemporaneous outflows. This precautionary flight to cash was more pronounced among funds exposed to greater redemption risk through shorter share restrictions. Hedge funds predominantly trading the cash-futures basis faced greater margin pressure and reduced UST exposures and repo borrowing the most. After the market turmoil subsided following Fed intervention, hedge fund returns recovered quickly, but UST exposures did not revert to pre-shock levels over the subsequent months.

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