Intermediary Asset Pricing
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
crisis 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.
He, Zhiguo and Arvind Krishnamurthy. 2013. Intermediary Asset Pricing. American Economic Review. 103(2): 732-770.