Why Do Demand Curves for Stocks Slope Down?
Representative agent models are inconsistent with existing empirical evidence for steep demand curves for individual stocks. This paper resolves the puzzle by proposing that stock prices are instead set by two separate classes of investors. While the market portfolio is still priced by individual investors based on their collective risk aversion, those individual investors also delegate part of their wealth to active money managers who use that capital to price stocks in the cross-section. In equilibrium the fee charged by active managers has to equal the before-fee alpha they earn; this endogenously determines the amount of active capital and the slopes of demand curves. A calibration of the model reveals that demand curves can indeed be steep enough to match the magnitude of many empirical findings, including the price effects for stocks added to (or deleted from) the S&P 500 index.
|Date of creation:||01 May 2004|
|Date of revision:||01 Sep 2008|
|Contact details of provider:|| Web page: http://icf.som.yale.edu/|
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Berk, Jonathan B, 1995. "A Critique of Size-Related Anomalies," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 275-86.
- Franklin Allen, 2001. "Do Financial Institutions Matter?," Center for Financial Institutions Working Papers 01-04, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Nicholas Barberis & Richard Thaler, 2002.
"A Survey of Behavioral Finance,"
NBER Working Papers
9222, National Bureau of Economic Research, Inc.
- Allen, Franklin & Gale, Douglas, 1994.
"Limited Market Participation and Volatility of Asset Prices,"
American Economic Review,
American Economic Association, vol. 84(4), pages 933-55, September.
- Allen, F. & Gale, D., 1991. "Limited Market Participation and Volatility of Asset Prices," Weiss Center Working Papers 2-92, Wharton School - Weiss Center for International Financial Research.
- Gale, D. & Allen, F., 1991. "Limited Market Participation and Volatility of Asset Prices," Weiss Center Working Papers 14-91, Wharton School - Weiss Center for International Financial Research.
- Jonathan B. Berk & Richard C. Green, 2002.
"Mutual Fund Flows and Performance in Rational Markets,"
FAME Research Paper Series
rp100, International Center for Financial Asset Management and Engineering.
- Jonathan B. Berk & Richard C. Green, 2004. "Mutual Fund Flows and Performance in Rational Markets," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1269-1295, December.
- Jonathan B. Berk & Richard C. Green, 2002. "Mutual Fund Flows and Performance in Rational Markets," NBER Working Papers 9275, National Bureau of Economic Research, Inc.
- Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
- Chen, Joseph & Hong, Harrison & Stein, Jeremy C., 2002.
"Breadth of ownership and stock returns,"
Journal of Financial Economics,
Elsevier, vol. 66(2-3), pages 171-205.
- Franklin Allen, 2001. "Presidential Address: Do Financial Institutions Matter?," Journal of Finance, American Finance Association, vol. 56(4), pages 1165-1175, 08.
When requesting a correction, please mention this item's handle: RePEc:ysm:somwrk:amz2458. See general information about how to correct material in RePEc.
If references are entirely missing, you can add them using this form.