Staff Reports
Leverage Asset Pricing
August 2013  Number 625
Revised September 2013
JEL classification: G10, G12

Authors: Tobias Adrian, Emanuel Moench, and Hyun Song Shin

We investigate intermediary asset pricing theories empirically and find strong support for intermediary book leverage as the relevant state variable. A parsimonious dynamic pricing model that uses detrended broker-dealer leverage as a price of risk variable, and innovations to broker-dealer leverage as pricing factor is shown to perform well in time series and cross sectional tests of a wide variety of equity and bond portfolios. The model outperforms alternative intermediary pricing specifications that use intermediary net worth as state variables, and performs well in comparison to benchmark asset pricing models. We draw implications for macroeconomic theories.

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