The Risk Premium on Balance Sheet Capacity

26 Pages Posted: 3 Apr 2017 Last revised: 21 Jul 2017

Anusar Farooqui

Indian Institute of Management---Udaipur; McGill University; Columbia University

Date Written: April 1, 2017

Abstract

We show that fluctuations in the risk-bearing capacity of US securities broker-dealers are priced in the cross-section of expected stock excess returns. We show that the intermediary risk premium dwarfs the premiums on benchmark factors both unconditionally and dynamically. A portfolio that tracks our intermediary factor sports a dramatically higher Sharpe ratio than benchmark portfolios. We find that the risk premium on balance sheet capacity contains significant macroeconomic information. Specifically, we document that the intermediary risk premium is a significant predictor of US real output growth and that the cyclical component of the intermediary risk premium predicts US recessions.

Keywords: Risk Appetite, Dynamic Asset Pricing, Time-Varying Risk Premium, Factor Investing

JEL Classification: G2, G12, E44

Suggested Citation

Farooqui, Anusar, The Risk Premium on Balance Sheet Capacity (April 1, 2017). Available at SSRN: https://ssrn.com/abstract=2944385 or http://dx.doi.org/10.2139/ssrn.2944385

Anusar Farooqui (Contact Author)

Indian Institute of Management---Udaipur ( email )

Mohanlal Sukhadia University Campus
Udaipur, Rajasthan 313001
India

McGill University ( email )

Montreal, Quebec H3A 2K6
Canada

Columbia University ( email )

New York, NY
United States

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