Demand Elasticity in Dynamic Asset Pricing
The demand-system approach identifies asset demand slopes using residual supply shocks, presuming these shocks move expected returns but not risk. In dynamic economies, risk is endogenous: investors retrade, so demand depends on the joint distribution of current and future returns, which changes as investors absorb a shock. The shock therefore changes the demand curve it traces, violating the exclusion restriction. In a calibrated multi-asset dynamic model, the measured slope is roughly 40% of its conceptual counterpart, implying substantially steeper demand curves than standard estimates suggest. The bias persists even if shocks are infinitesimal and transitory. We discuss potential empirical remedies.
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Copy CitationZhiguo He, Péter Kondor, and Jessica S. Li, "Demand Elasticity in Dynamic Asset Pricing," NBER Working Paper 34450 (2025), https://doi.org/10.3386/w34450.Download Citation
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