Broker-Dealer Leverage and the Cross-Section of Stock Returns

We document that average stock returns can be largely explained by their covariance with shocks to the aggregate leverage of security broker-dealers. Our single-factor leverage model compares favorably with standard multi-factor models in the cross-section of size and book-to-market portfolios and outperforms such models when considering momentum, industry, and Treasury bond portfolios. We interpret the risk captured by shocks to broker-dealer leverage as a reflection of unexpected changes in broader economic conditions.