TY  - JOUR
AU  - He,Zhiguo
AU  - Krishnamurthy,Arvind
TI  - Intermediary Asset Pricing
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 14517
PY  - 2008
Y2  - December 2008
UR  - http://www.nber.org/papers/w14517
L1  - http://www.nber.org/papers/w14517.pdf
N1  - Author contact info:
Zhiguo He
University of Chicago
Booth School of Business
E-Mail: Zhiguo.He@ChicagoBooth.edu

Arvind Krishnamurthy
Kellogg School of Management
Northwestern University
2001 Sheridan Road
Evanston, IL 60208
Tel: 847/491-2671
Fax: 847/491-5719
E-Mail: a-krishnamurthy@northwestern.edu
AB  - 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.
ER  -