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Financial Intermediaries and Asset Prices

Paper Session

Sunday, Jan. 8, 2017 1:00 PM – 3:00 PM

Sheraton Grand Chicago, Chicago Ballroom X
Hosted By: American Finance Association
  • Chair: Tyler Muir, Yale University

A Macroeconomic Model With Financially Constrained Producers and Intermediaries

Vadim Elenev
,
New York University
Tim Landvoigt
,
University of Texas-Austin
Stijn Van Nieuwerburgh
,
New York University

Abstract

We evaluate the quantitative effects of macroprudential policy. To do so, we solve a general equilibrium model with three types of agents and a government. Borrower-entrepreneurs produce output financed with long-term debt issued by financial intermediaries, subject to a leverage constraint. Intermediaries fund these loans combining deposits and their own equity, and are subject to a regulatory capital constraint. Savers provide funding to banks and to the government. Both entrepreneurs and banks make optimal default decisions. The government issues debt to finance budget deficits and to pay for bank rescue operations. We solve for macroeconomic quantities, the price of capital, the yield on safe bonds, and the credit spread. We study how financial and non-financial recessions differ, show that high credit spreads forecasts future declines in economic activity, and study macro-prudential policies. Policies that limit corporate leverage and financial leverage reduce welfare. Their benefits for financial and macro-economic stability are outweighed by the costs from a smaller-sized economy. The two types of macroprudential policies have different implications for the wealth distribution.

An Equilibrium Model of Institutional Demand and Asset Prices

Ralph Koijen
,
London Business School
Motohiro Yogo
,
Princeton University

Abstract

We develop an asset pricing model with rich heterogeneity in asset demand across investors, designed to match institutional holdings. The equilibrium price vector is uniquely determined by market clearing across institutional investors and households. We relate the model to Euler equations, mean-variance portfolio choice, factor models, and cross-sectional regressions on characteristics. We propose an instrumental variables estimator for the asset demand system to address the endogeneity of institutional demand and asset prices. Using U.S. stock market data, we illustrate how our approach could be used to understand the role of institutions in asset market movements, volatility, and predictability.

Intermediary Asset Pricing: New Evidence From Many Asset Classes

Zhiguo He
,
University of Chicago
Bryan Kelly
,
University of Chicago
Asaf Manela
,
Washington University-St. Louis

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 cross-sectional 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.

The Banking View of Bond Risk Premia

Valentin Haddad
,
Princeton University
David Sraer
,
University of California-Berkeley

Abstract

Banks’ exposure to fluctuations in interest rates strongly forecasts excess Treasury bond returns. This result is consistent with a bank-centric view of the market for interest rate risk. Banks’ activities — accepting deposits and making loans — naturally exposes their balance sheets to changes in interest rates. In equilibrium, the bond risk premium compensates banks for bearing these fluctuations: for instance, when consumers demand for fixed rate mortgages increases, banks have to scale up their exposure to interest rate risk and are compensated by an increase in bond risk premium. A key insight is that the net exposure of banks, rather than quantities of particular types of loans or deposits, reveals the risk premium.
Discussant(s)
Frederico Belo
,
University of Minnesota
Stefano Giglio
,
University of Chicago
Robert Richmond
,
New York University
Anna Cieslak
,
Duke University
JEL Classifications
  • G1 - Asset Markets and Pricing