Inelastic U.S. Equity Markets: New Evidence From A Reform of Fiduciary Duties
63 Pages Posted: 12 Aug 2024
Date Written: July 26, 2024
Abstract
We study the equity market implications of a reform in the laws that govern trust investments, implemented in a staggered fashion across U.S. states from 1986 to 2006. The introduction of the prudent investor rule systematically alters the relative attractiveness of stocks within the cross-section of U.S. equities for trusts. As trusts account for a substantial fraction of institutional equity holdings in our sample period, and since the reform does not pertain to other investors, our empirical setting provides a rare opportunity to study the impact of a regulatory change on institutional investor holdings and relative prices in the U.S. equity market. We show that, before the reform, trusts tilt their portfolios towards prudent stocks ("regulatory tilts"). After the law change, trusts undo these tilts which introduces large and predictable changes in demand. Consistent with a model of inelastic equity markets, we find long-lived outperformance of stocks bought by trusts after the law change relative to stocks sold by those funds. In this new and unique setting, we derive estimates of the price elasticity of demand of U.S. equities which are low and support the inelastic markets hypothesis.
Keywords: Inelastic Equity Markets, Demand Effects, Institutional Investors, Trusts, Prudent Man Laws
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