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Margin-Based Asset Pricing and Deviations from the Law of One Price

Author

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  • Nicolae Garleanu

    (University of California at Berkeley, NBER, and CEPR)

Abstract
In a model with multiple agents with different risk aversions facing margin constraints, we show how securities’ required returns are characterized both by their beta and their margins. Negative shocks to fundamentals make margin constraints bind, lowering risk free rates and raising Sharpe ratios of risky securities, especially for high-margin securities. Such a funding liquidity crisis gives rise to a “basis,” that is, a price gap between securities with identical cash-flows but different margins. In the time series, the basis depends on the shadow cost of capital which can be captured through the interest-rate spread between collateralized and uncollateralized loans, and, in the cross section, it depends on relative margins. We apply the model empirically to the CDS-bond basis and other deviations from the Law of One Price, and to evaluate the effects of unconventional monetary policy and lending facilities.

Suggested Citation

  • Nicolae Garleanu, 2010. "Margin-Based Asset Pricing and Deviations from the Law of One Price," 2010 Meeting Papers 1323, Society for Economic Dynamics.
    • Handle: RePEc:red:sed010:1323
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    Cited by:

    1. Robin Greenwood & Samuel G. Hanson, 2011. "Issuer Quality and the Credit Cycle," NBER Working Papers 17197, National Bureau of Economic Research, Inc.
    2. Robin Greenwood & Samuel G. Hanson, 2013. "Issuer Quality and Corporate Bond Returns," The Review of Financial Studies, Society for Financial Studies, vol. 26(6), pages 1483-1525.
    3. Markus K. Brunnermeier & Yuliy Sannikov, 2014. "A Macroeconomic Model with a Financial Sector," American Economic Review, American Economic Association, vol. 104(2), pages 379-421, February.
    4. Andrei Shleifer & Robert Vishny, 2011. "Fire Sales in Finance and Macroeconomics," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 29-48, Winter.
    5. Tiago Severo, 2012. "Measuring Systemic Liquidity Risk and the Cost of Liquidity Insurance," IMF Working Papers 2012/194, International Monetary Fund.
    6. Dan Vu Cao, 2010. "Collateral Shortages, Asset Price And Investment Volatility With Heterogeneous Beliefs," 2010 Meeting Papers 1233, Society for Economic Dynamics.

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