Long Term Asset Management Lecture
Do Intermediaries Matter for Aggregate Asset Prices? - LTAM 2018
Times when financial intermediaries such as investment banks, commercial banks, and hedge funds are in weak financial health often coincide with low aggregate asset prices and high risk premia. This correlation suggests that the health of the financial sector may be an important determinant of asset prices, but it is also possible that the balance sheets of the intermediaries are simply indicative of other market developments. For example, during the 2008 financial crisis, risk premia rose substantially and there was a drop in the risk-bearing capacity of financial intermediaries, but there were also other changes, such as an increase in household risk aversion, that could explain these developments.
Valentin Haddad and Tyler Muir find that measures of intermediary financial health, such as the leverage or net worth of intermediaries, have greater predictive power for asset classes that are more specialized and more intermediated, such as credit default swaps, commodities, and currencies. There is less predictive power for less-specialized asset classes such as stocks. They argue that the differences in predictability of more- vs. less-intermediated asset classes provide a lower bound for how much intermediaries matter in each class, and under this assumption, they decompose the variation in risk premia across asset classes based on the degree of intermediation and the relative predictability across asset classes. For example, they attribute about 80 percent of variation in risk premia in credit default swaps to intermediaries and about 30 percent of variation in risk premia of stocks to households. There is still a remaining fraction of variation for each asset class that they cannot assign to either based on their lower bounds. Overall, these results suggest a sizeable amount of variation in risk premia is attributable to intermediaries as well as households.