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

Mathias S. Kruttli, Phillip J. Monin, Lubomir Petrasek and Sumudu Watugala
Additional contact information
Phillip J. Monin: https://www.federalreserve.gov/econres/phillip-monin.htm
Lubomir Petrasek: https://www.federalreserve.gov/econres/lubomir-petrasek.htm

No 2021-038, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: 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.

Keywords: Hedge funds; Treasury markets; Relative value; Arbitrage; Liquidity; Redemption risk; Creditor constraints (search for similar items in EconPapers)
JEL-codes: G01 G11 G23 G24 (search for similar items in EconPapers)
Pages: 68 p.
Date: 2021-06-24
New Economics Papers: this item is included in nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2021-38

DOI: 10.17016/FEDS.2021.038

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