Why is Asset Demand Inelastic?

50 Pages Posted: 7 Nov 2022 Last revised: 15 Mar 2023

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 identify the source of this discrepancy and show that low demand elasticity estimates for individual stocks are not puzzling if price movements are not entirely associated with short-term discount rate changes. In a standard portfolio choice framework, we show that the demand elasticity is primarily determined by how expected returns impact investor portfolio weights in response to price movements. If prices only drop due to next-period discount rates (as most theoretical models assume), we show that demand elasticity will be high. But, if price movements are not entirely driven by next-period expected returns (as empirical estimates of elasticity measure), demand will be inelastic. Consistent with inelastic demand estimates, we find evidence of weak reversals or momentum at different horizons.

Keywords: Price elasticity, demand-based asset pricing

JEL Classification: G11, G12

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)

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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