If you’re ready for a serious education on market elasticity, demand system pricing, and stock market flows, you’ve come to the right place (disclaimer: don’t expect light entertainment). Today’s guest is Ralph Koijen, AQR Capital Management Professor of Finance and Fama Faculty Fellow at the University of Chicago, Booth School of Business. Tune in for a fascinating conversation about some of the most fundamental characteristics of our economy. To say we learned a lot from this conversation is an understatement, and we’re sure you’ll walk away with just as many lightbulb moments and impactful lessons as we did.
Key Points From This Episode:
- Ralph provides an in-depth explanation of demand system pricing. [0:02:48]
- An example of how valuations can be affected while the connection between fundamentals and valuations remain relatively unaffected. [0:08:18]
- How Ralph’s model for demand system asset pricing differs from other models. [0:41:26]
- The two components that investor demand is made up of. [0:14:54]
- Exploring the concept of latent demand and how to estimate it. [0:17:57]
- How the price impact from institutions and elasticity of markets has changed over time. [0:20:34]
- Understanding the surprising impact of households on stock market volatility in 2008. [0:20:34]
- How latent demand can be used to predict differences in expected returns. [0:25:46]
- Examples of factors that drive latent demand. [0:30:42]
- The most impactful group of investors (and why this is the case). [0:33:17]
- An overview of what would likely happen if the most influential investors switched to market cap indexing. [0:35:22]
- How huge firms influence the setting of prices. [0:36:25]
- Ralph shares his thoughts on the idea that index funds are distorting market prices as they continue to grow in magnitude. [0:35:22]
- What demand system pricing tells us about the effect of socially responsible investing on prices. [0:43:01]
- How US asset prices would be affected if foreign demand for US assets decreases. [0:35:22]
- Inelastic versus elastic markets. [0:47:23]
- Why prices are so much more volatile than fundamentals. [0:51:11]
- Comparing micro-elasticity and macro-elasticity. [0:52:18]
- Ways to estimate micro-elasticity and macro-elasticity, and the limitations of these approaches. [0:54:00]
- Ralph’s estimate of what the macro-elasticity is. [01:01:00]
- Risk factors that impact elasticity. [01:02:07]
- An example which shows how flows work. [01:03:32]
- Factors that impact how long the price impact of flows lasts. [01:05:24]
- Dividend irrelevance in inelastic markets. [01:10:30]
- The role of the increasing market share of cap weighted indices on market elasticity. [01:12:28]
- How investors should behave when markets are inelastic. [01:15:11]
- Ralph’s definition of success. [01:18:47]
