Bank-Intermediated Arbitrage

Abstract

We argue that post-crisis bank regulation can explain large, persistent deviations from parity on basis trades requiring leverage. Documenting the financing cost and balance sheet impact on a broad array of basis trades for regulated institutions, we show that the implied return on equity on such trades is considerably lower under post-crisis regulation. In addition, although hedge funds would serve as natural alternative arbitrageurs, we document that funds reliant on leverage from a global systemically important bank suffer significant declines in assets and returns relative to unlevered funds. Thus, post-crisis regulation not only affects the targeted banks directly but also spills over to unregulated firms that rely on bank intermediation for their arbitrage strategies.

Treasury Inconvenience Yields during the COVID-19 Crisis

“…Our paper contributes to the literature of intermediary-based asset pricingà la He and Krishnamurthy (2013a), especially those that highlight constraints on dealers such as Klingler and Sundaresan (2019), Jermann (2019), Fleckenstein and Longstaff (2020), Boyarchenko, Eisenbach, Gupta, Shachar, andTassel (2018), andHe, Khorrami, and. See He and Krishnamurthy (2018) for a recent survey (and Gromb and Vayanos (2010) for a survey on limits-of-arbitrage).…”

“…In particular, primary dealers are expected to participate in all issuance auctions of Treasuries, and have traditionally been the predominant purchasers at these auctions. 11 Dealers are also key intermediaries of the Treasury cash market, 8 We keep the details to a minimum, and refer to Fleming (1997), Fleming and Garbade (2004), Garbade, Keane, Logan, Stokes, and Wolgemuth (2010), and Baklanova, Copeland, and McCaughrin (2015) for additional details on Treasury and repo markets, Fleming and Rosenberg (2007) on dealers, and Duffie (2018) and Boyarchenko, Eisenbach, Gupta, Shachar, and Tassel (2018) on post-crisis regulations.…”

Treasury Inconvenience Yields During the Covid-19 Crisis

“…Our paper contributes to the literature of intermediary-based asset pricingà la He and Krishnamurthy (2013), especially those that highlight constraints on dealers such as He, Kelly, and Manela (2017), Klingler and Sundaresan (2019), Jermann (2019), Fleckenstein and Longstaff (2020), Boyarchenko, Eisenbach, Gupta, Shachar, andTassel (2018), andHe, Khorrami, and.…”

Bank foreign currency funding and currency markets: the case of Mexico post GFC

“…Compliance with banking regulations implemented after the global financial crisis increases the cost of 15 For example see Akram et al (2008). 16 See Boyarchenko et al (2018), Duffie (2017), Rime et al (2017). In addition, Hernandez (2014) studies the Mexican case in particular and shows how US and European funding liquidity conditions relate to the Mexican peso-US dollar foreign exchange markets.…”

“…7 Motivated by this, the paper examines the role of exogenous, business-model driven for-4 See Duffie (2017). 5 See Boyarchenko et al (2018), Rime et al (2017). 6 See Avdjiev et al (2017), Ivashina et al (2015).…”