Asset Collateralizability and the Cross-Section of Expected Returns

This paper studies the implications of credit market imperfections for the cross-section of stock returns. Theory implies that the tightness of financing con- straints is countercyclical. As a result, collateralizable capital provides insurance against aggregate shocks, because it can be used to relax financing constraints. We present a production-based general equilibrium model model to quantify the effect of the above channel on the cross-section of expected returns. Consistent with the predictions of our model, we find in the data that stock returns for firms with a larger share of non-collateralizable capital are on average 4.8% higher an- nually than those for firms with a lower share. Our model can quantitatively reproduce the magnitude of the return spread as observed in the data.