New Delhi, Sept. 16 -- India's market regulator is said to have given arbitrage mutual funds more flexibility in managing their positions, according to people familiar with the matter, seeking to draw a key source of liquidity into the struggling closing auction session for stocks.

The Securities and Exchange Board of India, or SEBI, has allowed these funds to temporarily carry unhedged positions of as much as 1% of their plans, said the people, who asked not to be identified because the details aren't public. Arbitrage mutual funds held a combined Rs.3 lakh crore ($31 billion) in assets at the end of August.

The relaxation is aimed at bringing liquidity into the closing auction session that has struggled to attract enough players since...