B01: Flexible Theoretical Models of Intermediary Asset Pricing
The main objective of the project is to develop and analyze general and flexible specifications of models of intermediary asset pricing. The baseline model follows He and Krishnamurthy (2012, 2013, 2018), featuring an endowment economy, investors with time-separable preferences, and a representative intermediary. Households and specialists contribute equity to the intermediary, who is the only one with access to risky assets. The equity contributed by households is limited to some constant multiple of the equity contributed by specialists (equity constraint). We extend this baseline model in several dimensions, including recursive preferences, stochastic multipliers for the equity constraint, a production economy, and heterogeneous intermediaries. Recursive preferences allow to separate risk aversion from the elasticity of intertemporal substitution, which has been shown to be relevant for asset pricing. With respect to equity multipliers, we plan to analyze exogenous multipliers that constitute additional risk, pro- and counter-cyclical multipliers that depend on the state of the economy or multipliers that depend on the endogenous asset prices. We want to assess their implications for price levels and dynamics as well as their potential for stabilizing or destabilizing the economy. The setup of a production economy will allow us to study the implications of intermediary frictions for the real economy. Here, the scope of decisions to be made widens, since now also investment becomes a choice variable. We want to assess to what degree the presence of intermediary frictions leads to a reduction in investment and output relative to the frictionless case. Furthermore, we want to study if they have stabilizing or destabilizing effects. Again, we want to analyze and compare different specifications of stochastic multipliers. Finally, we want to extend the special case with one intermediary to the analyses of multiple intermediaries, where each intermediary specializes in some asset class. We want to understand potential spill-over effects between seemingly unrelated agents or markets, which are relevant in particular during severe crises. We also aim at explaining empirically documented differences in intermediary behavior (e.g., with respect to pro- vs. counter-cyclical risky asset holdings) by different types of intermediary restrictions (e.g., with respect to short-term vs. long-term restrictions). The solution of such rich and potentially high-dimensional models with endogenous and exogenous state variables is a challenging task. It is thus a further objective of our work to develop efficient code to obtain reliable numerical (global) solutions for the newly developed equilibrium models.