Title: Financial intermediary risk appetite and asset prices
Description: This dissertation investigates the impact of financial intermediary risk appetite on asset prices. The first chapter shows that fluctuations in the risk appetite of leveraged financial institutions such as security broker-dealers forecast commodity returns at quarterly horizons. The result holds robustly both in-sample and out-of-sample and is particularly strong for energy commodities: the single variable is able to forecast up to 30% of the variation in quarterly crude oil returns. The pattern emerged shortly after the launch of commodity futures contracts and is consistent with a model in which the economic role of broker-dealers is to provide insurance to producers and end-users of commodities. I estimate cross-sectional prices of risk using an arbitrage- free asset pricing approach and show that innovations in broker-dealer risk appetite forecast commodity returns through their association with time-varying risk premia. Additional predictions of the model also receive support in the data. The second chapter, written jointly with Tobias Adrian and Hyun Song Shin, presents evidence that fluctuations in the aggregate balance sheets of financial intermediaries forecast exchange rate returns--at weekly, monthly, and quarterly frequencies, both in-sample and out-of-sample, and for a large set of countries. We estimate prices of risk using a cross-sectional, arbitrage-free asset pricing approach and show that balance sheets forecast exchange rates because of their association with time-varying risk premia. We provide a rationale for an intertemporal equilibrium pricing theory in which intermediaries are subject to balance sheet constraints.

The final chapter ties together recent literature on the forecastability of commodity returns and exchange rates using the insights developed in the first two chapters. I exhibit evidence that the forecastability of commodity returns by the risk appetite of financial intermediaries is an important dynamic that underlies the forecastability of commodity returns by the exchange rates of commodity exporters. The forward-looking nature of exchange rates may also be used to understand why fluctuations in financial intermediary risk appetite forecast changes in the exchange rates of commodity exporters at horizons as short as one week.