Asset Price Dynamics with Slow-Moving Capital American Finance Association Address Darrell Duffie Stanford University Atlanta, January, 2010 Acknowledgements: Adam Ashcraft, Nicolae G ˆ arleanu, Gaston Giroux, Jeremy Graveline, Gustavo Manso, Semyon Malamud, Lasse Pedersen, Bruno Strulovici, Tong-Sheng Sun, Kevin Wu
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Asset Price Dynamicswith Slow-Moving Capital
American Finance Association Address
Darrell DuffieStanford University
Atlanta, January, 2010
Acknowledgements: Adam Ashcraft, Nicolae Garleanu, Gaston Giroux, Jeremy
Graveline, Gustavo Manso, Semyon Malamud, Lasse Pedersen, Bruno Strulovici,
Tong-Sheng Sun, Kevin Wu
Time
Price
Efficient market price
Stationary illiquid market price
With limited capital mobility and supply shock
0 10 20 30 40 50 60 70 80 90 100−0.14
−0.12
−0.1
−0.08
−0.06
−0.04
−0.02
0
Days Since Effective Deletion Date
Exc
ess
Ret
urn
Mean Excess Return for S&P 500 Deletions
Figure 1: Cumulative returns for dropped S&P500 stocks.
−1
−3
−5
−7
−9
−11
Pric
e
Time0 20 40 60 80 100
Figure 2: Modeled price path with slow investors
Figure 3: An over-the-counter market.
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2
8.85
8.9
8.95
9
9.05
Pric
e, lo
w λ
Low λHigh λ 9.52
9.57
9.62
9.67
9.72
Pric
e, h
igh
λ
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 20
0.04
0.08
0.12
Calendar Time
Inst
anta
neou
s R
etur
n
Low λHigh λ
Figure 4: Source: Duffie, Garleanu, and Pedersen (2007).
Figure 5: A centralized market.
Figure 6: A hybrid market structure.
Capital per unit riskMarket 1
Capital per unit riskMarket 2
Price
of risk
Price
of risk
p1
q1
p2
q2
Figure 7: Capital migrates from markets with low risk premia to markets with high
risk premia. Duffie and Strulovici (2008).
1990 1992 199819961994 2000 2002
0
5
10
15
20
25
30
35 140
120
100
80
60
40
20
0
CAMARES price index of
CatXL covers
Insurance industry's annual natural
catastrophe loss burden in USD billion
Figure 8: Catastrophe risk: premiums and global volume of claims. Source: Swiss
Re.
Figure 9: Reinsurance risk premia by line. Source: Swiss Re.
43
-800
-600
-400
-200
0
200
400
1/7/
05
4/7/
05
7/7/
05
10/7
/05
1/7/
06
4/7/
06
7/7/
06
10/7
/06
1/7/
07
4/7/
07
7/7/
07
10/7
/07
1/7/
08
4/7/
08
7/7/
08
10/7
/08
1/7/
09
4/7/
09
7/7/
09
CDS Basis (in basis points) for Investment Grade (bold) and Speculative Grade Bonds. Source: Mitchell and Pulvino (2009)
Excess profits from CIP arbitrage (short dollar spot positions)
-0.15
-0.1
-0.05
0
0.05
0.1
0.15
0.2
0.25
0.308
-Mar
-06
08-M
ay-0
6
08-J
ul-0
6
08-S
ep-0
6
08-N
ov-0
6
08-J
an-0
7
08-M
ar-0
7
08-M
ay-0
7
08-J
ul-0
7
08-S
ep-0
7
08-N
ov-0
7
08-J
an-0
8
08-M
ar-0
8
08-M
ay-0
8
08-J
ul-0
8
08-S
ep-0
8
08-N
ov-0
8
08-J
an-0
9
08-M
ar-0
9
(pps
)
Long EURUSD spot
Short USDJPY spot
Long GBPUSD spot
Short USDCHF spot
source: Mancini-Griffoli and Ranaldo (2009)
Empirical Evidence from Supply-Shock Price Reactions
∙ Catastrophe risk insurance claims: Froot and O’Connell (1999).
∙ Fire sales from mutual fund redemptions: Coval and Stafford (2007).
∙ Impact of Ford-GM downgrade forced sale of bonds: Feldhutter (2009).
∙ Equity market-order imbalances: Andrade, Chang, and Seasholes (2005),
Hendershott and Seasholes (2006).
∙ Index recompositions: Chen, Noronha, and Singhal (2004), Greenwood
(2005), Mitchell, Pulvino, Stafford (2004).
∙ Stock and bond issuances: Newman and Rierson (2004), Kulak (2008),
Chaiserote (2008).
∙ Various financial-crisis broken arbitrages: Mitchell, Pedersen, and Pulvino
(2007), Collin-Dufresne (2009), Mancini-Griffoli and Ranaldo (2009), Mitchell
and Pulvino (2009).
A Sample of Related Theory
∙ Price behavior with intermediated asynchronous demands: Grossman and
Miller (1987), Brunnermeier and Pedersen (2009).
∙ Price reactions to supply shocks with search delays: Duffie, Garleanu,
Pedersen (2007), Duffie and Strulovici (2008).
∙ Stationary equilibrium with delayed trade: Garleanu (2009), Rosu (2009).
∙ Endogenous investor inattention: Duffie and Sun (1990); Abel, Eberly,