Date of Award

Summer 8-2020

Degree Type


Degree Name


Degree Program

Financial Economics


Economics and Finance

Major Professor

Sudha Krishnaswami

Second Advisor

Luca Pezzo

Third Advisor

Walter J. Lane

Fourth Advisor

Arja H. Turunen-Red


Even though they are parsimonious, financial intermediary pricing models deliver an impressive performance in the cross-section of expected returns. The premise of the theory behind such models is that intermediaries better represent the marginal investor because of their competency level as traders and because they are less exposed to frictions. In addition, researchers hint at market frictions contributing to the performance of factor models, whether they are theory-based or reduced-form. Motivated by the lack of empirical evidence, we study the performance of factor models conditional on frictions. First, we examine 13 frictions individually and find that they lack the ability to explain the cross-section of re- turns. Then, we create an index to represent the level of market frictions at each point in time. Importantly, We find that frictions collectively impact the performance of factor models. Consistent with the theories, we document that the performance of theory-based and reduced-form models differ depending on the level of frictions. In addition, we find evidence that intermediary-based models outperform household-based models, especially in periods of high frictions, as suggested by the theory. Our findings hold when using different specifications of the frictions index.


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