Why is Asset Demand Inelastic?

57 Pages Posted: 7 Nov 2022 Last revised: 16 Jan 2024

See all articles by Carter Davis

Carter Davis

Kelley School of Business, Indiana University

Mahyar Kargar

University of Illinois at Urbana-Champaign

Jiacui Li

David Eccles School of Business, University of Utah

Date Written: August 19, 2022

Abstract

Classic asset pricing models predict high demand elasticities: investors trade aggressively against price deviations. In contrast, empirical estimates are three orders of magnitude lower. To explain this gap, we use a portfolio choice framework to show that demand elasticity depends on two components: "price pass-through", which measures how price movements forecast returns, and "unspanned returns", which reflects an asset's distinctiveness relative to others. Contrary to classic model assumptions, we find evidence for low price pass-throughs and high unspanned returns. By considering these two channels, we can largely reconcile the difference between theoretical predictions and empirical estimates of demand elasticity.

Keywords: Price elasticity, price pass-through, spanning, demand system asset pricing, shrinkage.

JEL Classification: G11, G12, G14

Suggested Citation

Davis, Carter and Kargar, Mahyar and Li, Jiacui, Why is Asset Demand Inelastic? (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)

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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