Financial Intermediary Leverage, Volatility, and the Cross-Section of Asset Returns
29 Pages Posted: 25 Jun 2021
Date Written: June 20, 2021
Society needs financial intermediaries to create orderly efficient markets, to have informative prices, and to best allocate resources. However, when trust is eroded with high volatility and unpredictable events, financial crises are amplified and prices are distorted as financial intermediaries struggle to hold rapidly depreciating assets that are essential for economic recovery. Using a multi-factor model, I find that intermediary leverage, volatility, and more importantly their interaction, explain cross-sectional variations in expected returns. I propose an advancement based on the joint interaction between intermediary leverage and volatility to enable financial intermediaries to better manage their leverage in a rapidly evolving risk environment.
Keywords: cross sectional asset pricing, financial intermediation, leverage ratio
JEL Classification: G01, G12, G21
Suggested Citation: Suggested Citation