Complex Asset Markets

76 Pages Posted: 15 Aug 2016 Last revised: 23 Sep 2018

See all articles by Andrea L. Eisfeldt

Andrea L. Eisfeldt

UCLA Anderson School of Management

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Lei Zhang

The University of Hong Kong - School of Economics and Finance

Multiple version iconThere are 2 versions of this paper

Date Written: June 18, 2018

Abstract

Complex assets appear to have high average returns and high Sharpe ratios. However, despite these attractive attributes, participation in complex assets markets is very limited. We argue that this is because investing in complex assets requires a model, and investors’ individual models expose them to investor-specific risk. Investors with higher expertise have better models, and thus face lower risk. We construct a dynamic economy in which the joint distribution of wealth and expertise determines aggregate risk bearing capacity in the long-run equilibrium. In this equilibrium, more complex asset markets, i.e. those which are more difficult to model, have lower participation rates, despite having higher market- level Sharpe ratios, provided that asset complexity and expertise are complementary. In this case, higher expert demand reduces equilibrium required returns, depressing overall participation. Thus, our theory explains why complex assets can have “permanent alpha”, despite free entry.

Keywords: segmented markets, limits of arbitrage, heterogeneous agent models, industry equilibrium, firm size distribution

Suggested Citation

Eisfeldt, Andrea L. and Lustig, Hanno N. and Zhang, Lei, Complex Asset Markets (June 18, 2018). Available at SSRN: https://ssrn.com/abstract=2821381 or http://dx.doi.org/10.2139/ssrn.2821381

Andrea L. Eisfeldt (Contact Author)

UCLA Anderson School of Management ( email )

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Los Angeles, CA 90095-1481
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HOME PAGE: http://https://sites.google.com/site/andrealeisfeldt/

Hanno N. Lustig

Stanford Graduate School of Business ( email )

Stanford GSB
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Stanford, CA California 94305-6072
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3108716532 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Lei Zhang

The University of Hong Kong - School of Economics and Finance ( email )

K. K. Leung Building, Room 831
The University of Hong Kong
Hong Kong
Hong Kong

HOME PAGE: http://econleizhang.weebly.com/

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