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FOR 5230:  Financial Markets and Frictions - An Intermediary Asset Pricing Approach

Subject Area Social and Behavioural Sciences
Term since 2021
Project identifier Deutsche Forschungsgemeinschaft (DFG) - Project number 447617473
 
Understanding the structure and dynamics of risk premia is at the core of asset pricing. There is substantial variation of risk premia over time and across assets. One promising path to studying the variability in premia is to look at asset prices through the lens of frictions in financial intermediation. According to recent intermediary asset pricing models, such frictions are key to understanding asset prices and risk premia. The basic story works as follows: Direct investing is costly, so households give their money to intermediaries. Due to contracting frictions, regulatory constraints, or market entry barriers, intermediaries do not invest in full accordance with the preferences of households. As a result, intermediation frictions enter the pricing expressions for intermediated assets and impose a wedge between private valuation and market prices. Clearly, a significant amount of investment is intermediated, and there is ample evidence that intermediation frictions cause price movements in various markets. The vast amount of this literature is motivated by crises phenomena. However, the relevance of intermediary frictions is not limited to crisis periods. So there is a definite need for a better understanding of the general role of intermediaries with respect to asset pricing.As a Research Unit, we are guided by the theory on intermediary asset pricing. We want to sound out whether we can understand the big picture of heavily fluctuating prices and premia over time and across assets by a shift in paradigm: from the standard household perspective, with the notion that the household is always marginal, towards an intermediary perspective. If frictions in financial intermediation are important, they may allow prices to fluctuate more widely than suggested by standard models. Thus, instead of contributing to the vast literature that has produced a whole ``zoo'' of factors, we seek to identify key frictions and to separate their effects from classical risk factors. Starting from this, we aim to provide empirical strategies, models, and methods, use them to reach new insights about the formation of asset prices, and shape future research in the field.To reach our goal, we are proposing a concerted, coherent, and comprehensive research program that covers various intermediaries, frictions, as well as a wide spectrum of assets. With our concept, we envision to improve our understanding of the interplay between intermediary frictions and risk premia. Asset prices, risk premia, and their dynamics are highly important economic quantities central to decisions regarding, e.g., consumption vs. investment and saving for retirement. Our results are thus of pronounced importance for households, investors, public policy, corporate decision making, and the macroeconomy as a whole.
DFG Programme Research Units
International Connection Austria

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