The Commercial Bank Leverage Factor in U.S. Asset Prices

55 Pages Posted: 19 Nov 2020

See all articles by Marius Mihai

Marius Mihai

Widener University - School of Business Administration

Date Written: September 30, 2020

Abstract

I present novel results on a commercial bank leverage factor that drives U.S. asset prices with important implications for both the time-series and the cross-section of returns. To motivate these findings, I modify the recovery rate of assets in a disaster model to include aggregate credit growth as an additional macroeconomic risk factor. It turns out there is a positive relationship between the postulated "resilience" of an asset and the stage of aggregate credit recovery. The intuition is behavioral in nature: credit expansions (contractions) breed investor overoptimism (pessimism), asset "resilience" increases (decreases) and the risk-premium decreases (increases). Additional implications in the cross-section are generated by the interaction of the credit cycle with the stock-specific recovery rate. The commercial bank leverage factor has a larger effect on small-, less profitable-, and value-stocks. A simple buy-and-hold strategy of the market index at short- and medium-horizons illustrates how investors can earn significantly higher excess returns and Sharpe ratios in recoveries and early stages of an expansion as opposed to credit booms.

Keywords: Commercial Bank Leverage Factor, Risk-Premium, Sharpe Ratio, Cross-Section of Returns

JEL Classification: G21, G17, E51

Suggested Citation

Mihai, Marius, The Commercial Bank Leverage Factor in U.S. Asset Prices (September 30, 2020). Available at SSRN: https://ssrn.com/abstract=3703374 or http://dx.doi.org/10.2139/ssrn.3703374

Marius Mihai (Contact Author)

Widener University - School of Business Administration ( email )

Chester, PA 19013
United States

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