Financial Intermediaries and the Cross-Section of Asset Returns
58 Pages Posted: 23 Mar 2011 Last revised: 20 Nov 2014
Date Written: March 14, 2011
Financial intermediaries trade frequently in many markets using sophisticated models. Their marginal value of wealth should therefore provide a more informative stochastic discount factor (SDF) than that of a representative consumer. Guided by theory, we use shocks to the leverage of securities broker-dealers to construct an intermediary SDF. Intuitively, deteriorating funding conditions are associated with deleveraging and high marginal value of wealth. Our single-factor model prices size, book-to-market, momentum, and bond portfolios with an R2 of 77% and an average annual pricing error of 1% — performing as well as standard multi-factor benchmarks designed to price these assets.
Keywords: cross sectional asset pricing, financial intermediation
JEL Classification: G1, G12, G21
Suggested Citation: Suggested Citation