Prices Are Less Elastic For Less Diversifiable Demand

84 Pages Posted: 28 Mar 2022 Last revised: 20 Jun 2022

See all articles by Jiacui Li

Jiacui Li

David Eccles School of Business, University of Utah

Zihan Lin

Stanford University

Date Written: June 16, 2022

Abstract

We hypothesize and provide evidence that prices are more inelastic when demand is less diversifiable. Specifically, we decompose order-flow imbalance into several components with varying degrees of diversifiability and estimate their price impacts. The results reveal a continuum of price elasticities ranging from high elasticities at style/factor levels to low elasticities at idiosyncratic levels. Our findings are consistent with weaker liquidity pro- vision at less diversifiable levels—which may arise from investor risk aversion or portfolio constraints—and inconsistent with information-based price-impact mechanisms. Our findings might explain why “discount rate variation” matters to a greater extent as the level of aggregation rises.

Keywords: Price elasticity, liquidity provision, demand-based asset pricing

JEL Classification: G11, G12

Suggested Citation

Li, Jiacui and Lin, Zihan, Prices Are Less Elastic For Less Diversifiable Demand (June 16, 2022). Available at SSRN: https://ssrn.com/abstract=4038664 or http://dx.doi.org/10.2139/ssrn.4038664

Jiacui Li (Contact Author)

David Eccles School of Business, University of Utah ( email )

8123 SFEBB, 1655 Campus Center Dr
Salt Lake City, UT 84112
United States

HOME PAGE: http://https://www.jiacui-li.com/

Zihan Lin

Stanford University ( email )

Stanford, CA 94305
United States

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