DP13974 A Supply and Demand Approach to Equity Pricing

Author(s): Sebastien Betermier, Laurent Calvet, Evan Jo
Publication Date: August 2019
Date Revised: September 2019
Keyword(s): Anomalies, Asset Pricing, capital allocation, factor-based investing, General Equilibrium, production economy
JEL(s): G11, G12
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13974

This paper presents a frictionless neoclassical model of financial markets in which firm sizes, stock returns, and the pricing kernel are all endogenously determined. The model parsimoniously specifies the supply and demand of financial capital allocated to each firm and provides general equilibrium sizes and returns in closed form. We show that the interaction of supply and demand can coherently explain a large number of asset pricing facts. The equilibrium security market line is flatter than the CAPM predicts and can be nonlinear or downward-sloping. The model also generates the size, profitability, investment growth, value, asymmetric volatility, betting-against-beta, and betting-against-correlation anomalies, while also fitting the cross-section of firm characteristics.