Intermediary Leverage Shocks and Funding Conditions

The aggregate leverage of broker-dealers responds to demand and supply disturbances that have opposite effects on financial markets. Specifically, leverage supply shocks that relax broker-dealers' funding constraints increase leverage, liquidity, and returns and carry a positive price of risk, while leverage demand shocks also increase leverage but reduce liquidity and returns and carry a negative price of risk. Disentangling demand- and supply-like shocks resolves existing puzzles around the price of leverage risk and yields consistent evidence across many markets of a central role for intermediation frictions and dealers' aggregate leverage in asset pricing.