Short- and long-term demand curves for stocks: theory and evidence on the dynamics of arbitrage
- 1 March 2005
- journal article
- Published by Elsevier BV in Journal of Financial Economics
- Vol. 75 (3), 607-649
- https://doi.org/10.1016/j.jfineco.2004.03.007
Abstract
I develop a framework to analyze demand curves for multiple risky securities at extended horizons in a setting with limits-to-arbitrage. Following an unexpected change in uninformed investor demand for several assets, I predict returns of each security to be proportional to the contribution of that security's demand shock to the risk of a diversified arbitrage portfolio. I show that securities that are not affected by demand shocks but are correlated with securities undergoing changes in demand should experience returns related to their hedging role in arbitrageurs' portfolios. Finally, I predict a negative cross-sectional relation between post-event returns and the initial return associated with the change in demand. I confirm these predictions using data from a unique redefinition of the Nikkei 225 index in Japan, in which 255 stocks simultaneously undergo significant changes in index investor demand, causing more than ¥2,000 <!--mathContainer--> <!--Loading Mathjax--> billion of trading in one week and large price changes followed by subsequent reversals for all of the reweighted stocks.
Keywords
This publication has 17 references indexed in Scilit:
- Trading Volume: Definitions, Data Analysis, and Implications of Portfolio TheoryThe Review of Financial Studies, 2000
- Demand Curves for Stocks Do Slope Down: New Evidence from an Index Weights AdjustmentThe Journal of Finance, 2000
- How are stock prices affected by the location of trade?Journal of Financial Economics, 1999
- New Evidence on Stock Price Effects Associated with Changes in the S&P 500 IndexThe Journal of Business, 1997
- A Theory of the Dynamics of Security Returns around Market ClosuresThe Journal of Finance, 1994
- Noise Trader Risk in Financial MarketsJournal of Political Economy, 1990
- S&P 500 Cash Stock Price VolatilitiesThe Journal of Finance, 1989
- A Simple Model of Capital Market Equilibrium with Incomplete InformationThe Journal of Finance, 1987
- Does Delisting from the S&P 500 Affect Stock Price?CFA Magazine, 1986
- Continuous Auctions and Insider TradingEconometrica, 1985