Renting Balance Sheet Space: Intermediary Balance Sheet Rental Costs and the Valuation of Derivatives

A long-standing asset pricing puzzle is that the funding rates in derivatives contracts often differ from those in cash markets. We propose that the cost of renting intermediary balance sheet space may help resolve this puzzle. We study a persistent basis in what is arguably the largest derivatives market, namely, the interest rate futures market. This basis is strongly related to exogenous measures of intermediary balance sheet usage and proxies for the balance sheet costs imposed by debt overhang problems and capital regulation. These results extend to the cash derivatives bases documented in many of the other largest financial markets.