DFG Research Group: Financial Markets and Frictions - An Intermediary Asset Pricing Approach

A newly established research group entitled "Financial Markets and Frictions - an Intermediary Asset Pricing Approach" (Spokesperson: Professor Dr. Marliese Uhrig-Homburg) will start work in January 2022. As announced on December 10th, the German Research Foundation has approved the establishment of the research group for four years and the research group will receive a total of around 3.5 million euros.
 

Brief description

In nine subprojects, the participating researchers are dedicated to the role of intermediaries in the formation of securities prices. The research group is supported by finance colleagues from Karlsruhe, Frankfurt, Tübingen, Stuttgart and Münster. In addition, there is an international cooperation with the WU Vienna.

The spokesperson of the research group is Marliese Uhrig-Homburg. Furthermore, Julian Thimme (since 2019 Junior Professor for Finance at FBV) is involved in the research group with his own project. Philipp Schuster (meanwhile holder of the Chair of Finance at the University of Stuttgart) was still a junior research group leader at KIT/FBV during the application phase and is also part of the research group.

In addition to the KIT-based coordination project (under the responsibility of Marliese Uhrig-Homburg), three other subprojects are located at KIT. Philipp Schuster, Julian Thimme, and Marliese Uhrig-Homburg and their teams are conducting research on bond markets (Project "Fragmented Intermediation, Bond Risk Premiums, and Market Stability"), on option markets (Project "Intermediation Frictions, Trader Positions, and Option Prices"), and on the interplay between equity and option markets (Project "Characterization of Asset Pricing Anomalies").

Understanding the structure and dynamics of risk premia is at the core of asset pricing. There is substantial variation of risk premia over time and across assets. One promising path to studying the variability in premia is to look at asset prices through the lens of frictions in financial intermediation. According to recent intermediary asset pricing models, such frictions are key to understanding asset prices and risk premia. The basic story works as follows: Direct investing is costly, so households give their money to intermediaries. Due to contracting frictions, regulatory constraints, or market entry barriers, intermediaries do not invest in full accordance with the preferences of households. As a result, intermediation frictions enter the pricing expressions for intermediated assets and impose a wedge between private valuation and market prices.

Clearly, a significant amount of investment is intermediated, and there is ample evidence that inter-mediation frictions cause price movements in various markets. The vast amount of this literature is motivated by crises phenomena. However, the relevance of intermediary frictions is not limited to crisis periods. So there is a definite need for a better understanding of the general role of intermedia-ries with respect to asset pricing.
As a Research Unit, we are guided by the theory on intermediary asset pricing. We want to sound out whether we can understand the big picture of heavily fluctuating prices and premia over time and across assets by a shift in paradigm: from the standard household perspective, with the notion that the household is always marginal, towards an intermediary perspective. If frictions in financial inter-mediation are important, they may allow prices to fluctuate more widely than suggested by standard models. Thus, instead of contributing to the vast literature that has produced a whole “zoo” of factors, we seek to identify key frictions and to separate their effects from classical risk factors. Starting from this, we aim to provide empirical strategies, models, and methods, use them to reach new insights about the formation of asset prices, and shape future research in the field.

To reach our goal, we are proposing a concerted, coherent, and comprehensive research program that covers various intermediaries, frictions, as well as a wide spectrum of assets. With our concept, we envision to improve our understanding of the interplay between intermediary frictions and risk premia. Asset prices, risk premia, and their dynamics are highly important economic quantities central to decisions regarding, e.g., consumption vs. investment and saving for retirement. Our results are thus of pronounced importance for households, investors, public policy, corporate decision making, and the macroeconomy as a whole.

 

Research Grant

 

Working papers and publications on this DFG project

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Research Projects Currently Funded

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DFG Project: Cryptocurrency Valuation - An Asset Pricing Perspective

Currently, the German Research Foundation (DFG) is funding our project "The Value of Crypto Currencies - An Asset Pricing Perspective", in which we cooperate with Prof. Dr. Erik Theissen from the University of Mannheim.

Brief description:

Bitcoin, the first cryptocurrency, was originally designed to be a form of electronic cash that enables online payment without intermediation by financial institutions. While Bitcoin and other cryptocurrencies still serve that purpose, they are nowadays widely considered as financial assets and are held as investments or for speculative purposes. The CME and the Cboe, two of the world's largest derivatives exchanges, trade Bitcoin futures, and some authors consider cryptocurrencies a new asset class. Despite their growing popularity cryptocurrencies are not well understood. Why is someone ready to pay a five-digit dollar amount for a piece of data representing a unit of virtual cash? Why is private money without commodity backing valuable at all? Are we simply witnessing an enormous bubble or do modern cryptocurrencies rely on unique design features that justify at least part of the demand - for instance, the cryptographic techniques inducing a high degree of counterfeit safety or the protocols that set an upper bound on cryptocurrency supply acting as commitment device not to issue too much virtual money? Are such design features crucial value drivers? What else explains a cryptocurrency’s value and volatility?
Although, at a technical level, the unique features of cryptocurrencies and the underlying blockchain (or distributed ledger) technology have been extensively discussed from a computer science and a legal perspective, there is a lack of economic research to answer the questions above. We therefore seek to deepen the understanding of cryptocurrencies from an economic and finance perspective. More specifically: We want to develop an economic model that explains, from economic primitives, why cryptocurrencies have a non-zero value at all and understand which of the various design features of cryptocurrencies affect their value. There are three sub-goals that specify the overriding question: (1) We want to provide an overview and basic understanding of the unique design features of a cryptocurrency and to identify those that are relevant for the pricing and risk profile of cryptocurrencies. At this point, we will rely on both a literature review and an own exploratory empirical analysis of the variety of cryptocurrencies traded. (2) We plan to develop an economic model that allows to formally analyze the effects of those design features that are identified in step 1 as most important for a cryptocurrency’s value and volatility. Within this modelling approach, we intend to consider two main agent groups, the consumers and the miners, and their intergroup dynamics to derive price implications. (3) We seek to empirically assess the relevance of our model predictions using the cross-sectional variation between different cryptocurrencies.
The expected outcomes are not only novel from a theoretical perspective, but also highly relevant for informing the ongoing public debate on the merits and dangers of cryptocurrencies.

Working papers and publications on this DFG project: