Prices Are Less Elastic at More Aggregate Levels

Abstract

To understand the role of demand in asset pricing, a central parameter of interest is the price multiplier M: each $1 additional demand will change the market value of assets by $M. We argue that the price multiplier should depend on the willingness of investors to adjust their holdings in response to price movements. As long as investors are risk-averse, we should expect larger multipliers for demand in more aggregate (less diversifiable) return components. Using Lee-Ready classified aggressive order flow imbalance to measure demand, we find that price multipliers indeed form a spectrum that is increasing in the degree of aggregateness, and the differences in multiplier magnitudes cannot be accounted for by information-based mechanisms. Our findings suggest that investor demand could matter more for driving price fluctuations at more aggregate levels, and that existing estimates of factor investing profit capacities might be overly optimistic.