Staff Report 510

A Demand System Approach to Asset Pricing

Ralph S. J. Koijen
Motohiro Yogo | Consultant

Revised June 12, 2019

We develop an asset pricing model with flexible heterogeneity in asset demand across investors, designed to match institutional and household holdings. A portfolio-choice model implies characteristics-based demand when returns have a factor structure and expected returns and factor loadings depend on the assets’ own characteristics. We propose an instrumental variables estimator for the characteristics-based demand system to address the endogeneity of demand and asset prices. Using U.S. stock market data, we illustrate how the model could be used to understand the role of institutions in asset market movements, volatility, and predictability.
Note: This Staff Report was previously titled "An Equilibrium Model of Institutional Demand and Asset Prices."

Forthcoming In: Journal of Political Economy

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