Demand Elasticity in Dynamic Asset Pricing

Department: Finance

Speaker: Peter Kondor (LSE)

Room: TBD

Abstract

Standard demand elasticity estimation treats investors’ demand slopes as stable ob-jects that can be traced out by exogenous residual supply shifts. We show this identifi-cation strategy fails in dynamic settings: supply shocks cause demand curves to tilt andshift through general equilibrium effects. The mechanism is intuitive — investors’ demanddepends on the entire distribution of current and future returns, including volatility, co-variances, and correlations with investment opportunities. Supply shocks that changetoday’s prices inevitably reshape future return distributions as well, moving the demandcurve itself. We develop and calibrate a dynamic model to quantify this mismeasure-ment. The measured slope is approximately 40% of its conceptual counterpart, implyingthat demand curves are substantially steeper than estimated. This distortion operatesthrough two channels: endogenous risk (altered volatility and covariances) and amplifiedintertemporal hedging (changed correlation with investment opportunities). The distor-tion remains sizable even for infinitesimal or purely transitory shocks.