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Asset Pricing: Frictions and Market Power

Paper Session

Sunday, Jan. 3, 2021 10:00 AM - 12:00 PM (EST)

Hosted By: American Finance Association
  • Chair: Benjamin Hebert, Stanford University

Risk-Sharing, Investment, and Asset Prices According to Cournot and Arrow-Debreu

Daniel Neuhann
,
University of Texas-Austin
Michael Sockin
,
University of Texas-Austin

Abstract

We study the macroeconomic consequences of financial market concentration in a complete markets economy with production. We propose a theory in which differences in preferences, productivity, and risk exposure generate gains from trade, but these gains are not fully realized because some large agents internalize their impact on asset prices. In equilibrium, risk-sharing is incomplete and rents from strategic trading feed back into the real economy by distorting the marginal value of production. Along with an increase in valuations, the model can generate a joint decline in investment, productivity, risk-free rates and the market risk premium. Welfare losses from strategic trading can be measured using asset market data, and are largest in the deepest markets.

Resolving Asset-Pricing Puzzles Using Price-Impact

Xiao Chen
,
Rutgers University
Jin Hyuk Choi
,
Ulsan National Institute of Science and Technology
Kasper Larsen
,
Rutgers University
Duane Seppi
,
Carnegie Mellon University

Abstract

We solve in closed-form a continuous-time Nash equilibrium model in which a finite number of exponential investors continuously consume and trade strategically with price-impact. Compared to the analogous Pareto-efficient equilibrium model, price-impact has an amplification effect on risk-sharing distortions that helps resolve the interest rate puzzle and the stock-price volatility puzzle. However, price impact has little effect on the equity premium puzzle.

Arbitrage with Financial Constraints and Market Power

Vincent Fardeau
,
Higher School of Economics

Abstract

I study how financial constraints affect liquidity provision and welfare under different structures of the arbitrage industry. In competitive markets, financial constraints may impair arbitrageurs' ability to provide liquidity, thereby reducing other investors' welfare. Instead, in imperfectly competitive markets, I characterize situations in which imposing constraints on arbitrageurs leads to a Pareto improvement relative to a no-constraint case. Further, unlike the competitive case, a drop in arbitrage capital does not always lead to a reduction in market liquidity. A subtle interaction between financial constraints and arbitrageurs' market power generates these Pareto improvement and novel comparative statics.

Price Destabilizing Speculation: The Role of Strategic Limit Orders

Suman Banerjee
,
Stevens Institute of Technology
Ravi Jagannathan
,
Northwestern University
Kai Wang
,
Stevens Institute of Technology

Abstract

We show that under quantity competition with only a few strategic sellers, a large speculator with access to storage facilities can destabilize prices and profit from it. Through clever use of a combination of limit and market orders, the speculator can lower the price while buying and raise the price while selling. This creates price volatility even though there is no fundamental uncertainty in the economy and all market participants act rationally. When there is free disposal, the speculator uses a combination of limit and stop-loss order, and the resulting market price is more volatile
Discussant(s)
Ana Babus
,
Washington University in St. Louis
Nicolae Garleanu
,
University of California-Berkeley
Jonathan Wallen
,
Stanford University
Yajun Wang
,
City University of New York-Baruch College
JEL Classifications
  • G1 - Asset Markets and Pricing