Abstract: We develop a model in which mortgage leverage available to households depends on the risk bearing capacity of financial intermediaries. Our model features a novel transmission mechanism from Wall Street to Main Street, as borrower households choose lower leverage and consumption when intermediaries are distressed. The model has financially constrained young and unconstrained middle-aged households in overlapping generations. Young households choose higher leverage and riskier mortgages than the middle-aged, and their consumption is particularly sensitive to credit supply. Relative to a standard model with exogenous credit constraints, the macroeconomic importance of intermediary net worth is magnified through its effects on household leverage, house prices, and consumption demand. The model quantitatively demonstrates how recessions with housing crises differ from those driven only by productivity, and how a growing demand for safe assets replicates many features of the 2000s credit boom and increases the severity of future financial crises.
Abstract: We document differing risk-free rates in a range of asset classes, providing a uniquely clean measure of segmentation between markets. The asset markets we consider are the government bond market, commodity markets for precious metals, exchange rate markets and option markets. We find that risk-free rates across markets can deviate for prolonged periods of time and we characterize market segmentation through the speed of convergence. We analyze how shocks propagate across rate spreads and develop an aggregate arbitrage index which captures the common variation of these spreads across markets. We further present a novel high-frequency measure of the convenience yield on government bonds, which equals 38 basis points on average and grows substantially during periods of financial distress. We argue that option-market-implied risk-free rates provide a convenience-yield-free and effectively credit-risk-free measure of time preference measured accurately at a minutely frequency. This makes such rates a strong candidate for the risk free benchmark rate and we explore a range of empirical asset pricing applications.