Demand Discovery and Asset Pricing

63 Pages Posted: 8 Jun 2004

See all articles by Michael F. Gallmeyer

Michael F. Gallmeyer

University of Virginia (UVA) - McIntire School of Commerce

Duane J. Seppi

Carnegie Mellon University - David A. Tepper School of Business

Burton Hollifield

Carnegie Mellon University - David A. Tepper School of Business

Date Written: May 2005

Abstract

Dynamic trading of long-dated securities exposes investors to resale price risk due to uncertainty about the future asset demands of their trading counter-parties. This paper specifically models trading and asset pricing when investors are asymmetrically informed about each other's preferences.

Through a process we call demand discovery, trading reveals private information about counter-parties' preferences and, hence, about the preference-component in future prices. Demand discovery leads to endogenous joint dynamics in prices, trading volume, price volatility, and expected returns. As a result, trading volume and market liquidity are forward-looking proxies for preference risk in future prices. Demand discovery provides an alternative explanation to transaction costs for the empirical relationship between market liquidity and future returns.

Keywords: Liquidity, Demand Discovery, Asset Pricing, Asymmetric Information

JEL Classification: G11, G13, G15

Suggested Citation

Gallmeyer, Michael F. and Seppi, Duane J. and Hollifield, Burton, Demand Discovery and Asset Pricing (May 2005). AFA 2005 Philadelphia Meetings. Available at SSRN: https://ssrn.com/abstract=555602 or http://dx.doi.org/10.2139/ssrn.555602

Michael F. Gallmeyer (Contact Author)

University of Virginia (UVA) - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-243-4043 (Phone)
434-924-7074 (Fax)

HOME PAGE: http://www.commerce.virginia.edu/faculty_research/facultydirectory/Pages/Gallmeyer.aspx

Duane J. Seppi

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
412-268-2298 (Phone)
412-268-8896 (Fax)

Burton Hollifield

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
(412) 268-6505 (Phone)
(412) 268-6837 (Fax)

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