Tuesday, November 27, 2007

 

Downward Sloping Demand Curves for Stocks. Marzena Rostek presented "Frequent Trading and Price Impact in Thin Markets," (with Marek Weretka)today at Nuffield. It's a simple approach to downward-sloping demands for assets. Suppose there are a number of traders with CARA utility functions and stock returns are normal, so the traders care only about mean and variance. Each trader holds some portfolio of stocks. He would like to diversify, but if he puts some of his stock on the market, he has market power and will push down the price, since other people will have to be paid to hold more of that kind of risk. As a result, he will hold back some of the stock rather than diversify fully. Also, in way I do not fully understand this can explain splitting a trade up across periods. It is not for informational reasons-- there is full information in this model-- but because if I try to trade more of my stock in a period, I will drive down the price, keeping other people's quantity offered constant.

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