Intermediary Asset Pricing

Zhiguo He and Arvind Krishnamurthy

No 14517, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We present a model to study the dynamics of risk premia during crises in asset markets where the marginal investor is a financial intermediary. Intermediaries face a constraint on raising equity capital. When the constraint binds, so that intermediaries' equity capital is scarce, risk premia rise to reflect the capital scarcity. We calibrate the model and show that it does well in matching two aspects of crises: the nonlinearity of risk premia during crisis episodes; and, the speed of adjustment in risk premia from a cri- sis back to pre-crisis levels. We use the model to quantitatively evaluate the effectiveness of a variety of central bank policies, including reducing intermediaries' borrowing costs, infusing equity capital, and directly intervening in distressed asset markets. All of these policies are effective in aiding the recovery from a crisis. Infusing equity capital into intermediaries is particularly effective because it attacks the equity capital constraint that is at the root of the crisis in our model.

JEL-codes: G01 G2 G28 (search for similar items in EconPapers)
Date: 2008-12
New Economics Papers: this item is included in nep-cba, nep-dge and nep-ure
Note: CF AP
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Citations: View citations in EconPapers (21)

Published as He, Zhiguo, and Arvind Krishnamurthy. 2013. "Intermediary Asset Pricing." American Economic Review, 103(2): 732-70. DOI: 10.1257/aer.103.2.732

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