Regulatory Uncertainty and the Hedge Fund Liquidity Circle

Enhanced regulatory oversight and greater regulatory uncertainty in the aftermath of the 2007/08 financial crisis contribute to changes in the liquidity provision profile of hedge funds. Analysing a sample of 1,624 funds operating during these major shifts in regulatory policy, we find that hedge funds reduce their market liquidity exposure and realign their market-making activities towards liquid stocks. These effects are more pronounced for funds with higher flow-performance sensitivity and mitigated for funds with low operational risks and those connected to the largest US-based prime brokers