Leverage Asset Pricing
45 Pages Posted: 5 Sep 2013
Date Written: August 2013
We investigate intermediary asset pricing theories empirically and find strong support for models that have intermediary leverage as the relevant state variable. A parsimonious model that uses de-trended dealer leverage as a price-of-risk variable, and innovations to dealer leverage as a pricing factor, is shown to perform well in time series and cross-sectional tests of a wide variety of equity and bond portfolios. The model outperforms alternative specifications of intermediary pricing models that use intermediary net worth as a state variable, and it performs well in comparison to benchmark asset pricing models. We draw implications for macro-economic modeling.
Keywords: return predictability, cross-sectional asset pricing, financial intermediation, macro-finance
JEL Classification: G10, G12
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