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

51 Pages Posted: 14 Feb 2011 Last revised: 6 May 2023

See all articles by Nicolae Garleanu

Nicolae Garleanu

University of California, Berkeley - Haas School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Lasse Heje Pedersen

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

Multiple version iconThere are 2 versions of this paper

Date Written: February 2011

Abstract

In a model with heterogeneous-risk-aversion agents facing margin constraints, we show how securities' required returns are characterized both by their betas and their margin requirements. 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 "bases," that is, price gaps between securities with identical cash-flows but different margins. In the time series, bases depend 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, they depend on relative margins. We test the model empirically using the CDS-bond bases and other deviations from the Law of One Price, and use it to evaluate central banks' lending facilities.

Suggested Citation

Garleanu, Nicolae Bogdan and Pedersen, Lasse Heje, Margin-Based Asset Pricing and Deviations from the Law of One Price (February 2011). NBER Working Paper No. w16777, Available at SSRN: https://ssrn.com/abstract=1759849

Nicolae Bogdan Garleanu (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

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National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Lasse Heje Pedersen

AQR Capital Management, LLC ( email )

Greenwich, CT
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Copenhagen Business School - Department of Finance ( email )

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Denmark

New York University (NYU) ( email )

Stern School of Business
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New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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