A Supply and Demand Approach to Capital Markets

We develop an empirically tractable supply and demand system of financial markets, which explains the cost and quantity of capital used by individual firms. Investor preferences, biases, and risk assessments drive capital supply, while a firm’s profitability and other characteristics drive demand. Firm sizes and capital costs are endogenously determined in general equilibrium. Using theoretically motivated instruments, we estimate the supply and demand schedules of over 1,200 U.S. firms. Our system produces accurate forecasts of firm sizes and capital costs. We use the estimated system to quantify the equilibrium sensitivities of size and capital cost to firm and investor characteristics.

Keywords: Asset pricing, capital allocation, capital budgeting, general equilibrium, factor-based investing, production economy, sustainable investing.

JEL Classification: G11, G12

Suggested Citation: Suggested Citation

Betermier, Sebastien and Calvet, Laurent E. and Jo, Evan, A Supply and Demand Approach to Capital Markets (April 10, 2023). Proceedings of Paris December 2021 Finance Meeting EUROFIDAI - ESSEC, Available at SSRN: https://ssrn.com/abstract=3440147 or http://dx.doi.org/10.2139/ssrn.3440147