Correlated Demand Shocks and Asset Pricing

82 Pages Posted: 14 Feb 2024

See all articles by Byungwook Kim

Byungwook Kim

University of California, Irvine - Paul Merage School of Business

Date Written: January 24, 2024

Abstract

I propose a mechanism through which institutional investors' correlated demand shocks provide a source of risk in asset pricing. Institutional investors have mandates to beat a similar market index. During periods of strong stock market performance, their incentive to outperform intensifies, as more of them fall short of the market index. This incentive induces procyclical risk-taking behavior among institutional investors, generating correlated demand shocks that amplify stocks' market risk. Stocks with higher exposure to correlated demand exhibit elevated market betas and risk premia (8.5% per year). Quasi-experiments using exogenous changes in index membership support a causal interpretation of the mechanism.

Keywords: Asset pricing, Benchmarking, Demand shocks, Institutional investors

JEL Classification: G1, G2

Suggested Citation

Kim, Byungwook, Correlated Demand Shocks and Asset Pricing (January 24, 2024). Available at SSRN: https://ssrn.com/abstract=4705500 or http://dx.doi.org/10.2139/ssrn.4705500

Byungwook Kim (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Paul Merage School of Business
Irvine, CA California 92697-3125
United States

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