In a model with heterogeneous-risk-aversion agents facing margin constraints, we show how securities' required returns increase in both 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 credit default swap-bond bases and other deviations from the Law of One Price, and use it to evaluate central banks' lending facilities. (JEL G01, G12, G13, E44, E50)The paramount role of funding constraints becomes particularly salient during liquidity crises, with the one that started in 2007 being an excellent case in point. Banks unable to fund their operations closed down, and the funding problems spread to other investors, such as hedge funds, that relied on bank funding. Therefore, traditional liquidity providers became forced sellers, interest-rate spreads increased dramatically, Treasury rates dropped sharply, and central banks stretched their balance sheets to facilitate funding. These funding problems had significant asset-pricing effects, the most extreme example being the failure of the Law of One Price (LoOP): Securities with (nearly)We are grateful for helpful comments from Markus Brunnermeier, Xavier Gabaix, Andrei Shleifer, and Wei Xiong, as well as from seminar participants at the Bank of Canada,
