Abstract
Using the most comprehensive dataset of leveraged funds known to the literature, we measure the market-wide shadow cost of leverage constraints and examine its pricing implications. The shadow cost averages 0.56% per annum from 2006 to 2016, spikes upon quarter-ends when banks face tighter capital requirements, positively predicts future betting-against-beta (BAB) returns, and negatively correlates with contemporaneous BAB returns. Stocks that underperform when the shadow cost increases earn 0.64% more per month. Overall, our shadow cost measure fits the predictions of leverage-constraint based theories better than the widely-used TED spread.
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