Leveraged Funds and the Shadow Cost of Leverage Constraints
60 Pages Posted: 1 Oct 2018 Last revised: 28 Mar 2019
Date Written: February 7, 2019
Using the most comprehensive dataset of leveraged funds known to the literature, we measure the market-wide shadow cost of leverage constraints and examine its pricing implications. The shadow cost averages 0.51% per annum from 2006 to 2016, spikes upon quarter-ends when financial intermediaries file financial reports, positively predicts future betting-against-beta (BAB) returns, and negatively correlates with contemporaneous BAB returns. Stocks that underperform when the shadow cost increases earn 0.75% more per month. Overall, our shadow cost measure fits the predictions of leverage-constraint based theories better than the widely used TED spread. We demonstrate two natural applications of our shadow cost measure.
Keywords: Leverage Constraints, Shadow Cost, Financial Intermediaries, Leveraged Funds
JEL Classification: G11, G12, G17, G23
Suggested Citation: Suggested Citation