NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Intermediary Asset Pricing

Zhiguo He, Arvind Krishnamurthy

NBER Working Paper No. 14517
Issued in December 2008
NBER Program(s):      CF   AP

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.

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This paper was revised on December 5, 2011

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w14517

Published: 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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