Federal Reserve Board
Institutional Affiliation: Federal Reserve Board
Information about this author at RePEc
NBER Working Papers and Publications
|March 2017||Asset Mispricing|
with Francis A. Longstaff, Lubomir Petrasek: w23231
We use a unique dataset of corporate bonds guaranteed by the full faith and credit of the U.S. to test a number of recent theories about why asset prices may diverge from fundamental values. These models emphasize the role of funding liquidity, slow-moving capital, the leverage of financial intermediaries, and other frictions in allowing mispricing to occur. Consistent with theory, we find there are strong patterns of commonality in mispricing and that changes in dealer haircuts and funding costs are significant drivers of mispricing. Furthermore, mispricing can trigger short-term margin and funding-cost spirals. Using detailed bond and dealer-level data, we find that most of the cross-sectional variation in mispricing is explained by differences in dealer funding costs, inventory position...