Working Paper: NBER ID: w21920
Authors: Zhiguo He; Bryan Kelly; Asaf Manela
Abstract: We find that shocks to the equity capital ratio of financial intermediaries—Primary Dealer counterparties of the New York Federal Reserve—possess significant explanatory power for crosssectional variation in expected returns. This is true not only for commonly studied equity and government bond market portfolios, but also for other more sophisticated asset classes such as corporate and sovereign bonds, derivatives, commodities, and currencies. Our intermediary capital risk factor is strongly pro-cyclical, implying counter-cyclical intermediary leverage. The price of risk for intermediary capital shocks is consistently positive and of similar magnitude when estimated separately for individual asset classes, suggesting that financial intermediaries are marginal investors in many markets and hence key to understanding asset prices.
Keywords: No keywords provided
JEL Codes: G01; G12; G21; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| shocks to the equity capital ratio of financial intermediaries (G21) | cross-sectional variation in expected returns across various asset classes (G11) |
| intermediary capital ratio falls (G21) | marginal value of wealth rises (E21) |
| intermediary capital shocks (F65) | expected returns (G17) |
| intermediary capital ratio (G24) | price of risk for intermediary capital shocks (G19) |
| intermediary capital ratio (G24) | marginal value of capital by institutional investors (E22) |
| intermediary capital ratio (G24) | risk price estimates (G17) |