How (Not) to Identify Demand Elasticities in Dynamic Asset Markets

We evaluate approaches to estimating demand elasticities in dynamic asset markets, both theoretically and empirically. We establish strict, necessary conditions that the dynamics of instrumented asset price variation must satisfy for valid identification. We illustrate these insights in a general equilibrium model of dynamic trade and derive the magnitude of biases that arise when these conditions are violated. Estimates based on static IO models are severely biased when the instrumented price variation is persistent or predictable. Empirically, we show that commonly used instruments yield elasticity estimates that are off by orders of magnitude, or even have the wrong sign. In contrast to standard multiplier calculations, our theory characterizes the dynamic asset market interventions required to sustain a given price path support process, with direct implications for policies such as Quantitative Easing (QE).