Financial Intermediaries During Times of Stress
Paper Session
Saturday, Jan. 3, 2026 2:30 PM - 4:30 PM (EST)
- Emil Siriwardane, Harvard University
Risk-averse Dealers in a Risk-free Market -- The Role of Trading Desk Risk Limits
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 provide a micro-foundation for the link between market volatility and market liquidity in dealer-intermediated OTC markets.In times of crisis, policy prescriptions such as deregulation alone may not be sufficient to induce risk-taking by dealer intermediaries. Moreover, to address market functioning issues, policy actions that address the funding costs of intermediaries would not be as effective as policies that remove risks from intermediary balance sheets directly."
Do Intermediaries Help Mitigate the Contagious Effects of Runs?
Abstract
In this paper, we examine the behavior of financial intermediaries during a run involving mutual funds and shadow banks. Our setting is based in India where investors fund shadow banks via debt mutual funds. For our analysis, we exploit the unexpected failure of a large shadow bank. The failure of a shadow bank potentially signals distress in the industries where it operates. Investors plausibly revised their beliefs after this information event and exited mutual funds with a high allocation to shadow banks, irrespective of whether these banks operate in similar industries as the failed shadow bank (affected shadow banks). This investor response would have spread contagion to shadow banks operating in different industries (unaffected shadow banks). Mutual funds, however, selectively reduced allocation to affected shadow banks and shielded unaffected ones from the investor run. On the other hand, closed-end funds facing no redemption pressure held onto their allocation in shadow banks. Therefore, the fundamentals themselves did not warrant liquidation. Overall, the intermediary’s choice to liquidate certain shadow banks minimized the inefficiency caused by the run. We highlight this liquidation choice as a hitherto unexplored role of intermediaries.Discussant(s)
Moritz Lenel
,
Princeton University
Hillary Stein
,
Federal Reserve Bank of Boston
William Diamond
,
University of Pennsylvania
JEL Classifications
- G2 - Financial Institutions and Services