In a model with heterogeneous-risk-aversion agents facing margin constraints, we show how securities' required returns are characterized both by their betas and their margin requirements.Negative shocks to fundamentals make margin constraints bind, lowering risk-free rates and raising Sharpe ratios of risky securities, especially for high-margin securities.Such a funding-liquidity crisis gives rise to "bases," that is, price gaps between securities with identical cash-flows but different margins.In the time series, bases depend on the shadow cost of capital, which can be captured through the interest-rate spread between collateralized and uncollateralized loans, and, in the cross section, they depend on relative margins.We test the model empirically using the CDS-bond bases and other deviations from the Law of One Price, and use it to evaluate central banks' lending facilities.
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