Intermediary Asset Pricing

53 Pages Posted: 12 May 2012

Multiple version iconThere are 2 versions of this paper

Date Written: February 27, 2012


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 pre-crisis 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.

Keywords: Liquidity, LTCM Crisis, Subprime Crisis, Delegated Portfolio Management, Financial Institutions, Asset Pricing, Collateral, Credit

JEL Classification: G12, G2, E44

Suggested Citation

He, Zhiguo and Krishnamurthy, Arvind, Intermediary Asset Pricing (February 27, 2012). American Economic Review, Forthcoming, Available at SSRN:

Zhiguo He (Contact Author)

Stanford University - Knight Management Center ( email )

655 Knight Way
Stanford, CA 94305-7298
United States

Arvind Krishnamurthy

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-2671 (Phone)
847-491-5719 (Fax)