Impact of Demand Shocks on the Stock Market: Evidence from Chinese IPOs

Abstract

The inelastic markets hypothesis states that the aggregate stock market price elasticity of demand is small, implying that flows have large impacts on prices. We exploit demand shocks created as investor funds are frozen and unfrozen during Chinese IPOs to estimate the impact of demand shocks on the Chinese stock market. Using brokerage account records, we observe the selling and buying as investors raise cash to subscribe for IPOs and then reinvest the funds that supported unsuccessful subscriptions. Using an instrumental variables estimator, a 10 bps demand shock increases the aggregate stock market level by between 30 and 48 bps.

Keywords: Inelastic markets hypothesis, demand shocks, Chinese stock market, initial public offering

JEL Classification: G11, G12, G18, G24