Knowledge that Transforms

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.

To enforce insider trading laws, financial regulators require top executives to make their own-company trades public. One implication of this regulatory focus is that executives below the top fly under the radar. We use administrative register data from Norway to examine whether executives below the top in listed companies earn abnormal returns on purchases in own-company stock. We find evidence of abnormal returns on such trades, about 50 to 100 basis points at the 1-month horizon. The abnormal returns on purchases in other stocks are negative, making high investor ability an unlikely explanation.