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In Search of the Origins of Financial Fluctuations: The Inelastic Markets Hypothesis

Seminar by Ralph Koijen

15th September 2020 – On-Line

In this seminar Professor Ralph Koijen will challenge some of your fundamental assumptions about capital markets.   Ralph Koijen returns to the LQG to deliver a seminar on his most recent paper co-authored with Xavier Gabaix of Harvard, which will inform and (re?)-educate in equal measure.  The paper, available to download here  has implications for all market practitioners, portfolio managers, risk professionals, traders and more. If you thought trading <30% of average daily volume was not going to have impact – well, think again! Confused by the effects of QE… well… this paper suggests some plausible reasons and explanations.


Xavier Gabaix
Harvard University – Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Ralph S. J. Koijen
University of Chicago – Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)


We develop a framework to theoretically and empirically analyze the fluctuations of the aggregate stock market. Households allocate capital to institutions, which are fairly constrained, for example operating with a mandate to maintain a fixed equity share or with moderate scope for variation. As a result, the price elasticity of demand of the aggregate stock market is small, so flows in and out of the stock market have large impacts on prices. Using the recent method of granular instrumental variables, we find that investing $1 in the stock market increases the market’s aggregate value by about $5. We also show that we can trace back the time variation in the market’s volatility to flows and demand shocks of different investors.

We also analyze how key parts of macro-finance change if markets are inelastic. We show how pricing kernels and general equilibrium models can be generalized to incorporate flows, which makes them amenable to use in more realistic macroeconomic models, and to policy analysis. Our calibration implies that government purchases of equities have a non-trivial impact on prices. Corporate actions that would be neutral in a rational model, such as share buybacks, have substantial impacts too.

Our framework allows us to give a dynamic economic structure to old and recent datasets comprising holdings and flows in various segments of the market. The mystery of apparently random movements of the stock market, hard to link to fundamentals, is replaced by the more manageable problem of understanding the determinants of flows in inelastic markets. We delineate a research agenda that can explore a number of questions raised by this analysis, and might lead to a more concrete understanding of the origins of financial fluctuations across markets.

Ralph Koijen

University of Chicago – Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Ralph S.J. Koijen is the AQR Capital Management Professor of Finance and Fama Faculty Fellow at the University of Chicago Booth School of Business. He is also a Research Associate at the National Bureau of Economic Research and a Research Fellow of the Center for Economic Policy Research. He is a co-director of the NBER Asset Pricing program. He serves as a co-editor of the Review of Financial Studies. Professor Koijen was awarded the 2019 Fischer Black Prize by the American Finance Association, given biennially to the top financial economics scholar under the age of 40.

Professor Koijen’s research focuses on finance, insurance, and macroeconomics. His research has been published in the American Economic Review, Econometrica, the Journal of Political Economy, the Quarterly Journal of Economics, the Journal of Finance, the Review of Financial Studies, and the Journal of Financial Economics. His research has been covered in popular media, such as the Financial Times, the Wall Street Journal, and The Economist.

Before joining Chicago Booth in 2018, Professor Koijen was a Professor of Finance at the London Business School and NYU Stern, and an Assistant and Associate Professor of Finance at Chicago Booth. He received his undergraduate degree in Econometrics from Tilburg University and his Ph.D. in Finance from Tilburg University.