Institutional Capital and Bond Mispricings (CAPMIS)

Abstract:

I study the effect of financial institutions’ capital constraints on asset prices. In normal times, institutions have abundant capital to invest and eliminate deviations from the fair prices of assets. However, when investors suffer losses and capital becomes scarce, they unwind positions leading to large mispricings between assets with similar risk, amplification of price drops, and contagion across asset classes, thereby creating systemic risk and resulting in crises. The project plans to build theoretical models and confirm their predictions in government bond prices and exchange rates using a new measure of international capital constraints.