An Information-Based Explanation for Inelastic Demand

58 Pages Posted: 7 Nov 2022

See all articles by Carter Davis

Carter Davis

Kelley School of Business, Indiana University

Mahyar Kargar

Gies College of Business, University of Illinois at Urbana-Champaign

Jiacui Li

David Eccles School of Business, University of Utah

Date Written: August 19, 2022

Abstract

In many frictionless asset-pricing models, investor demand curves are virtually flat. Koijen and Yogo (2019), in contrast, estimate surprisingly inelastic demand. In this paper, we investigate the role of information in addressing this puzzle. In a noisy rational expectation equilibrium model, we show that uninformed investors are rationally reluctant to trade against price movements driven by informed investors, implying uninformed inelastic demand. To test this prediction, we use a firm-level vector autoregressive model (VAR) and verify that price changes predict only small fluctuations in the next year's expected returns for uninformed investors. We find that an investor who only observed public information would rationally have a demand elasticity of 0.15. Using three portfolio-based proxies of informedness, we further empirically verify that more informed institutions have higher demand elasticities.

Keywords: Price elasticity, demand-based asset pricing

JEL Classification: G11, G12

Suggested Citation

Davis, Carter and Kargar, Mahyar and Li, Jiacui, An Information-Based Explanation for Inelastic Demand (August 19, 2022). Available at SSRN: https://ssrn.com/abstract=4195089 or http://dx.doi.org/10.2139/ssrn.4195089

Carter Davis

Kelley School of Business, Indiana University ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

HOME PAGE: http://https://sites.google.com/site/carterkentdavis/

Mahyar Kargar (Contact Author)

Gies College of Business, University of Illinois at Urbana-Champaign ( email )

HOME PAGE: http://mahyarkargar.com

Jiacui Li

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

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

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