Working Paper: NBER ID: w14366
Authors: Zhiguo He; Arvind Krishnamurthy
Abstract: We develop a model in which the capital of the intermediary sector plays a critical role in determining asset prices. The model is cast within a dynamic general equilibrium economy, and the role for intermediation is derived endogenously based on optimal contracting considerations. Low intermediary capital reduces the risk-bearing capacity of the marginal investor. We show how this force helps to explain patterns during financial crises. The model replicates the observed rise during crises in Sharpe ratios, conditional volatility, correlation in price movements of assets held by the intermediary sector, and fall in riskless interest rates.
Keywords: No keywords provided
JEL Codes: E44; G12; G18; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low intermediary capital (E22) | decreased risk-bearing capacity of the marginal investor (G41) |
| low intermediary capital (E22) | patterns during financial crises (G01) |
| decreased risk-bearing capacity of the marginal investor (G41) | rise in Sharpe ratios (G19) |
| decreased risk-bearing capacity of the marginal investor (G41) | rise in conditional volatility (C22) |
| decreased risk-bearing capacity of the marginal investor (G41) | fall in riskless interest rates (E43) |
| low intermediary capital (E22) | asset price movements (G19) |