4 / 2017-04-21 06:15:03

Leverage Risk and Intermediary Asset Pricing: Evidence in China

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We document how the Chinese trust companies transform credit in the shadow banking and amplify leverage in capital market. The empirical evidences show that trust companies' leverage can explain asset returns in both cross section and time series. The prices of their leverage risk are not only statistically significant but also economically large, which is consistent with the leveraged-based asset pricing model predictions. In contrast, security companies' leverage possesses much less power to explain asset return even though they are the legitimate fund providers to margin trade and short sell stocks. Our results confirm that leveraged investments are mainly driven by credit transformation and leverage magnification through trust-bank cooperation in shadow banking. We also find that leverage can better explain bubble and dust in the equity market and our results complement the intermediary asset pricing theory.