Working Paper: NBER ID: w24224
Authors: Matthias Fleckenstein; Francis A. Longstaff
Abstract: Recent theory suggests that balance sheet frictions and constraints faced by financial intermediaries can have major asset pricing implications. We propose a new measure of the impact of these constraints on intermediary funding costs that is based on the implied cost of renting intermediary balance sheet space. On average, balance sheet constraints add 81 basis points to intermediary funding costs, but the impact often exceeds 200 basis points during a crisis. We find that these balance sheet costs have real effects on intermediary investment decisions and asset holdings. Increases in balance sheet costs are associated with short-term increases in the use of derivatives, but longer-term declines in risk-taking by financial institutions. Balance sheet costs introduce a wedge between on- and off-balance-sheet investments which may help resolve a number of asset pricing puzzles.
Keywords: balance sheet constraints; funding costs; asset pricing; financial intermediaries
JEL Codes: G12; G13; G21; G23; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Balance sheet constraints (G32) | Intermediary funding costs (G21) |
| Balance sheet costs (G32) | Broker-dealer leverage (G24) |
| Balance sheet costs (G32) | Asset growth rates (G19) |
| Equity capital requirements (G32) | Balance sheet costs (G32) |
| Balance sheet costs (G32) | Use of derivatives (C69) |
| Balance sheet costs (G32) | Risk-taking behaviors (D91) |
| Balance sheet constraints (G32) | Asset pricing (G19) |
| Balance sheet constraints (G32) | Market liquidity (G19) |