Abstract: Recent approaches to asset pricing involve the estimation of demand systems for financial securities in which investors are permitted to have non-pecuniary tastes over cash flow-irrelevant asset characteristics. We investigate theoretical foundations of demand-system asset pricing using multiple approaches to integrating tastes with portfolio choice. Our analysis raises several conceptual issues, including the appropriate notion of no arbitrage, the pricing of “redundant” assets, and the cardinal interpretation of taste parameters. These issues imply multiple barriers to identifying demand systems for financial securities from observational data, and raise questions about the structural interpretation of financial demand elasticities. We discuss how these issues affect counterfactuals constructed from estimated demand systems.
Abstract: This paper proposes a mechanism through which institutional investors' correlated demand shocks provide a source of risk in asset pricing. Institutional investors have a mandate to beat a similar market index, such as the S&P 500. During periods of strong stock market performance, their incentive to outperform intensifies due to a larger proportion of them falling short of the market index. I show that this incentive leads to procyclical risk-taking behavior among institutional investors, resulting in correlated demand shocks that amplify stocks' market risk. Stocks with higher exposure to correlated demand exhibit elevated market betas and risk premia. This endogenous risk commands an 8.52% annual return premium within decile portfolios, which is fully explained by the differences in market betas across the portfolios. Quasi-experiments using exogenous changes in index membership support a causal interpretation of the mechanism.
Abstract: This paper uses the reinvestment of corporate payouts by financial institutions as a nonfundamental shock to prices of other stocks held in the same portfolio. Exploiting the separation between announcement and payment dates, we find dividends, in particular, generate payment date price pressure, but no announcement date news spillovers. We estimate an asset demand elasticity of 1.25 and document a releveraging market feedback effect on investment, where firms respond to price increases by issuing debt and use the funds to invest. Through this mechanism, $10 paid in dividends by the average firm translates into $2 of investment at other firms.
Discussant: Erik Loualiche, University of Minnesota
