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

44 Pages Posted: 8 Dec 2009

See all articles by Lasse Heje Pedersen

Lasse Heje Pedersen

AQR Capital Management, LLC; Copenhagen Business School - Department of Finance; New York University (NYU); Centre for Economic Policy Research (CEPR)

Garleanu Nicolae

affiliation not provided to SSRN

Multiple version iconThere are 2 versions of this paper

Date Written: November 2009

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

Pedersen, Lasse Heje and Nicolae, Garleanu, Margin-Based Asset Pricing and Deviations from the Law of One Price (November 2009). NYU Working Paper No. 2451/28344, Available at SSRN: https://ssrn.com/abstract=1519255

Lasse Heje Pedersen (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

New York University (NYU) ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Garleanu Nicolae

affiliation not provided to SSRN

No Address Available

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