The Elastic Markets Hypothesis

Abstract

This paper presents new evidence on the response of macro asset prices to exogenous changes in quantities. In contrast to Koijen and Gabaix (2021), we show evidence that the market for stocks can be inelastic in the short-run, but remain elastic in the long-run (the price elasticity of the aggregate stock market with respect to quantities are less than one or that $1 of flows leads to less than a $1 in price increases). We also present a model of sticky portfolio adjustments with fixed rebalancing periods and quadratic rebalancing adjustment costs showing how the model is consistent with our empirical evidence.

Keywords: Asset Pricing, Macro-Finance, International Financial Markets, Elastic Markets, Inelastic Markets, Event Studies JEL Codes: G12, G14, G15