The Collateralizability Premium

This paper studies the implications of credit market frictions for the cross-section of expected stock returns. A common prediction of macroeconomic theories of credit market frictions is that the tightness of financial constraints is countercyclical. As a result, capital that can be used as collateral to relax such constraints provides insurance against aggregate shocks and should command a lower risk compensation compared non-collateralizable assets. Based on a novel measure of asset collateralizability, we provide empirical evidence that supports the above prediction. A long-short portfolio constructed from firms with low and high asset collateralizability generates an average excess return of around 7.96% per year. We develop a general equilibrium model with heterogeneous firms and financial constraints to quantitatively account for the effect of collateralizability on the cross-section of expected returns.