Staff Reports
Financial Intermediaries and the Cross-Section of Asset Returns
Previous title: "Broker-Dealer Leverage and the Cross-Section of Stock Returns"
July 2010  Number 464
Revised September 2013
JEL classification: G1, G12, G21

Authors: Tobias Adrian, Erkko Etula, and Tyler Muir

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 R2 of 77 percent and an average annual pricing error of 1 percent—performing as well as standard multi-factor benchmarks designed to price these assets.

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