Bank-Intermediated Arbitrage - FEDERAL RESERVE BANK of NEW YORK

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Staff Reports

Bank-Intermediated Arbitrage

Number 858
June 2018 Revised July 2018

JEL classification: G01, G21, G23, G28

Authors: Nina Boyarchenko, Thomas M. Eisenbach, Pooja Gupta, Or Shachar, and Peter Van Tassel

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.

Available only in PDF

AUTHOR DISCLOSURE STATEMENT(S)

Nina Boyarchenko
The author declares that she has no relevant or material financial interests that relate to the research described in this paper.

Thomas M. Eisenbach
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.

Pooja Gupta
The author declares that she has no relevant or material financial interests that relate to the research described in this paper.

Or Shachar
The author declares that she has no relevant or material financial interests that relate to the research described in this paper.

Peter Van Tassel
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.