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Financial Intermediaries and the Cross‐Section of Asset Returns
Author(s) -
ADRIAN TOBIAS,
ETULA ERKKO,
MUIR TYLER
Publication year - 2014
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12189
Subject(s) - deleveraging , stochastic discount factor , leverage (statistics) , financial intermediary , capital asset pricing model , economics , intermediary , financial economics , marginal value , coupon , business , monetary economics , finance , microeconomics , debt , machine learning , computer science
Financial intermediaries trade frequently in many markets using sophisticated models. Their marginal value of wealth should therefore provide a more informative stochastic discount factor (SDF) than that of a representative consumer. Guided by theory, we use shocks to the leverage of securities broker‐dealers to construct an intermediary SDF. Intuitively, deteriorating funding conditions are associated with deleveraging and high marginal value of wealth. Our single ‐factor model prices size, book‐to‐market, momentum, and bond portfolios with an R 2 of 77% and an average annual pricing error of 1%—performing as well as standard multifactor benchmarks designed to price these assets.