Two Essays on Demand-Based Asset Pricing
Author | : Paul Huebner |
Publisher | : |
Total Pages | : 0 |
Release | : 2023 |
Genre | : |
ISBN | : |
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In Chapter 1, I develop a framework to quantify which features of investors' trading strategies lead to momentum in equilibrium. Specifically, I distinguish two channels: persistent demand shocks, capturing underreaction, and the term structure of demand elasticities, representing an intensity of arbitrage activity that decreases with investor horizon. I introduce both aspects of dynamic trading into an asset demand system and discipline the model using the joint behavior of portfolio holdings and prices. I estimate the demand of institutional investors in the U.S. stock market between 1999 and 2020. On average, investors respond more to short-term than longer-term price changes: the term structure of elasticities is downward-sloping. My estimates suggest that this channel is the primary driver of momentum returns. Moreover, in the cross-section, stocks with more investors with downward-sloping term structures of elasticities exhibit stronger momentum returns by 7% per year. In Chapter 2 (with Valentin Haddad and Erik Loualiche), we develop a framework to theoretically and empirically analyze how investors compete with each other in financial markets. In the classic view that markets are fiercely competitive, if a group of investors changes its behavior, other investors adjust their strategies such that nothing happens to prices. We propose a demand system with a flexible degree of strategic response and estimate it for institutional investors in the U.S. stock market. Investors react to the behavior of others in the market: when less aggressive traders surround an investor, she trades more aggressively. However, this strategic reaction is not nearly as strong as the classic view. Our estimates suggest that when a group of investors changes its behavior, the response of other investors only counteracts half of the direct impact. This result implies that the rise in passive investing over the last 20 years has led to substantially more inelastic aggregate demand curves for individual stocks by about 15%.