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Federal Reserve Bank of New York
Staff Reports
Bank-intermediated arbitrage
Nina Boyarchenko
Thomas M. Eisenbach
Pooja Gupta
Or Shachar
Peter Van Tassel
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.


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Nina Boyarchenko & Thomas M. Eisenbach & Pooja Gupta & Or Shachar & Peter Van Tassel, Bank-intermediated arbitrage, Federal Reserve Bank of New York, Staff Reports 858, 01 Jun 2018, revised 01 Jul 2018.
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Keywords: bank regulation; arbitrage; hedge funds
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