Are Intermediary Constraints Priced?

Wenxin Du, Benjamin M. Hébert, Amy Wang Huber

NBER Working Paper No. 26009
Issued in June 2019, Revised in May 2020
NBER Program(s):Asset Pricing, International Finance and Macroeconomics

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 contributes substantially to the volatility of the stochastic discount factor, is correlated with both other near-arbitrages and intermediary wealth measures, and appears to be priced consistently across various asset classes.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w26009