Research
How Competitive is the Stock Market? Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing with Valentin Haddad and Erik Loualiche
Revise & Resubmit, American Economic Review
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
The Making of Momentum: A Demand-System Perspective
WFA 2023 Brattle Group Ph.D. Candidate Award
I develop a framework to quantify which features of investors’ dynamic trading strategies lead to momentum in equilibrium. I distinguish persistent demand shocks, capturing underreaction, and the term structure of demand elasticities, representing arbitrage intensities decreasing with investor horizon. I introduce both channels into an asset demand system that I estimate from institutional investors’ portfolio holdings and prices. Investors respond more to short-term than longer-term price changes: the term structure of elasticities is downward-sloping, creating momentum, whereas demand shocks mean-revert, contributing toward reversal. Stocks with more investors with downward-sloping term structures exhibit stronger momentum returns by 7% per year.