26 Pages Posted: 3 Apr 2017 Last revised: 21 Jul 2017
Date Written: April 1, 2017
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: Suggested Citation