Review of Financial Studies Vol. 36 No. 4 2023

Are Intermediary Constraints Priced?

Wenxin Du¹; Benjamin Hébert²; Amy Wang Huber³

¹ University of Chicago, Federal Reserve Bank of New York, and NBER , USA · ² Stanford University and NBER , USA · ³ Stanford University , USA

Abstract

Violations of no-arbitrage conditions measure the shadow cost of intermediary constraints. Intermediary asset pricing and intertemporal hedging together imply that the risk of these constraints tightening is priced. We describe a “forward CIP trading strategy” that bets on CIP violations shrinking and show that its returns help identify the price of this risk. This strategy yields the highest returns for currency pairs associated with the carry trade. The strategy’s risk substantially contributes to the volatility of the stochastic discount factor, is correlated with both other near-arbitrages and intermediary wealth measures, and appears to be consistently priced across various asset classes.

DOI

10.1093/rfs/hhac050

Volume

36

Issue

4

Pages

1464-1507

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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