The Making of Momentum: A Demand-System Perspective
Job Market Paper - Latest version available above!
I develop a framework to quantify which features of investors’ trading strategies lead to momentum in equilibrium. Specifically, I distinguish two channels: persistent demand shocks, capturing underreaction, and the term structure of demand elasticities, representing an intensity of arbitrage activity that decreases with investor horizon. I introduce both aspects of dynamic trading into an asset demand system and discipline the model using the joint behavior of portfolio holdings and prices. I estimate the demand of institutional investors in the U.S. stock market between 1999 and 2020. On average, investors respond more to short-term than longer-term price changes: the term structure of elasticities is downward-sloping. My estimates suggest that this channel is the primary driver of momentum returns. Moreover, in the cross-section, stocks with more investors with downward-sloping term structures of elasticities exhibit stronger momentum returns by 7% per year.
How Competitive is the Stock Market? Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing with Valentin Haddad and Erik Loualiche
WFA 2022 Elsevier Best Paper on Financial Institutions
2021 Q-Group Jack Treynor Prize
We develop a framework to theoretically and empirically analyze investor competition in financial markets. The classic view assumes that markets are very competitive: if a group of investors changes its behavior, other investors react such that nothing happens in equilibrium. Our framework quantifies the strength of the competitive response. We estimate a demand system of institutional investors in the US stock market accounting for two layers of equilibrium: how investors compete with each other in setting their strategies and how prices adjust to clear asset markets. We find that investors react to the behavior of others in the market: when less aggressive traders surround an investor she trades more aggressively. This reaction reduces the equilibrium consequences of changes in individual behavior by 60%. However, it also implies that the stock market is far from the competitive ideal. A consequence of this result is that the large increase in passive investing over the last 20 years has led to substantially more inelastic aggregate demand curves for individual stocks, by about 15%.
Featured: Financial Times, Risk.net, UCLA Anderson Review