Presidential Address: Asset Price Dynamics with Slow‐Moving Capital

Abstract

I describe asset price dynamics caused by the slow movement of investment capital to trading opportunities. The pattern of price responses to supply or demand shocks typically involves a sharp reaction to the shock and a subsequent and more extended reversal. The amplitude of the immediate price impact and the pattern of the subsequent recovery can reflect institutional impediments to immediate trade, such as search costs for trading counterparties or time to raise capital by intermediaries. I discuss special impediments to capital formation during the recent financial crisis that caused asset price distortions, which subsided afterward. After presenting examples of price reactions to supply shocks in normal market settings, I offer a simple illustrative model of price dynamics associated with slow-moving capital due to the presence of inattentive investors.I ADDRESS THE IMPLICATIONS for asset price dynamics of the apparent slow movement of investment capital to trading opportunities. The arrival of new capital to an investment opportunity can be delayed by fractions of a second in some markets, for example an electronic limit-order-book market for equities, or by months in other markets, such as that for catastrophe risk insurance. Accordingly, prices respond to supply or demand shocks with a sharp reaction because of the relatively small subset of capital (and thus risk-bearing capacity) that is immediately available to absorb a shock on short notice. Such a price impact is substantially reversed over time as additional capital becomes available. The amplitude of the immediate price impact and the pattern of the subsequent recovery can reflect many sorts of attention costs to trade as well as institutional impediments to capital movement, such as search costs for trading * Darrell

Securities Trading by Banks and Credit Supply: Micro-Evidence

“…Our results suggest that trading banks with higher capital can buy more of the securities that had a larger drop in price, especially lower-rated and long-term securities, as higher equity capital provides buffers to absorb potential negative shocks in these riskier securities. Moreover, the results are also consistent with models of fire sales and lack of arbitrage capital Vishny, 1992, 1997;Allen and Gale, 1994Duffie, 2010;Acharya, Shin, and Yorulmazer, 2013).…”

Speculation and Hedging in Segmented Markets

“…We further analyze how the cost of capital and price informativeness of these two assets depend on interesting model parameters, such as the number of L-traders and the profitability of speculative positions in We emphasize that the basic premise underlying our results is that markets are segmented in terms of the ability to move capital across markets and trade in different markets due to various frictions, but not so much in terms of price information. In other words, capital is relatively segmented and slow moving (e.g., Duffie 2010), but information is relatively integrated and fast moving, and traders actively use this information (e.g., Cespa and Foucault 2012). In fact, we show in Appendix B.2 that our results hinge on the ability of traders to observe and understand market prices even in the markets in which they do not trade.…”

“…In the international context, a variety of theories have been put forward to explain the "home bias" puzzle. In his presidential address, Duffie (2010) suggests that due to slow movement of investment capital, many trading opportunities cannot be exploited by investors who want to take advantage of them.…”

Concentrated Capital Losses and the Pricing of Corporate Credit Risk

“…The importance of capital market frictions is central to theoretical models of limits to arbitrage (Shleifer and Vishny (1997); Kyle and Xiong (2001)), slow moving capital (Duffie (2010); Acharya, Shin, and Yorulmazer (2013); Duffie and Strulovici (2012)), and financial intermediary-based asset pricing (Brunnermeier and Sannikov (2014); He and Krishnamurthy (2013); Adrian and Boyarchenko (2013)). On the empirical side, examples of previous studies on asset pricing with limited investment capital include Froot and O'Connell (2008), Gabaix, Krishnamurthy, and Vigneron (2007), Mitchell, Pedersen, and Pulvino (2007), Coval and Stafford (2007), Chen, Joslin, and Ni (2014b), Acharya, Schaefer, and Zhang (2014), and Adrian, Etula, and Muir (2014).…”