Intermediary Asset Pricing

Abstract

We model the dynamics of risk premia during crises in asset markets where the marginal investor is a financial intermediary. Intermediaries face an equity capital constraint. Risk premia rise when the constraint binds, reflecting the capital scarcity. The calibrated model matches the nonlinearity of risk premia during crises and the speed of reversion in risk premia from a crisis back to precrisis levels. We evaluate the effect of three government policies: reducing intermediaries borrowing costs, injecting equity capital, and purchasing distressed assets. Injecting equity capital is particularly effective because it alleviates the equity capital constraint that drives the model's crisis. (JEL E44, G12, G21, G23, G24)

Concentrated Capital Losses and the Pricing of Corporate Credit Risk

“…In absolute value, the price of credit risk rises almost twice as much following a loss, relative to how much it drops following a capital gain. 58 Again, this is exactly what we would expect in lieu of the theoretical results from models like He and Krishnamurthy (2013).…”

“…He and Krishnamurthy (2013) or Brunnermeier and Sannikov (2014). 31 In this specification, the standard error on the point estimate for mega-buyer outside capital fluctuations is small, most likely because the panel gives me good statistical precision.…”

“…The importance of capital market frictions is central to theoretical models of limits to arbitrage (Shleifer and Vishny (1997); Kyle and Xiong (2001)), slow moving capital (Duffie (2010); Acharya, Shin, and Yorulmazer (2013); Duffie and Strulovici (2012)), and financial intermediary-based asset pricing (Brunnermeier and Sannikov (2014); He and Krishnamurthy (2013); Adrian and Boyarchenko (2013)). On the empirical side, examples of previous studies on asset pricing with limited investment capital include Froot and O'Connell (2008), Gabaix, Krishnamurthy, and Vigneron (2007), Mitchell, Pedersen, and Pulvino (2007), Coval and Stafford (2007), Chen, Joslin, and Ni (2014b), Acharya, Schaefer, and Zhang (2014), and Adrian, Etula, and Muir (2014).…”

“…20 e.g. He and Krishnamurthy (2013), Adrian and Boyarchenko (2013), and Brunnermeier and Sannikov (2014). Even within this literature, it is unclear whether leverage should be measured using book values or market values.…”

Banks and Market Liquidity

“…Thus, this article lies at the intersection of three strands of the literature (see the references provided earlier): (i) the literature on financial market liquidity; (ii) the asset-substitution literature, and (iii) the literature on banks' role in providing agents with stores of value. The effect of funding/capital constraints on intermediaries' risk-absorption capacity has been analyzed by a large literature (e.g., Vayanos, 2002, 2010b;Brunnermeier and Pedersen, 2009;He and Krishnamurthy 2013).…”