Downwards sloping demand curves for stock?

Abstract

PurposeThe purpose of the analysis is to estimate price elasticities of demand for individual FTSE‐100 stocks between 1 August 1994 and 31 July 1995.Design/methodology/approachThis paper measures excess demand in order to measure the slope of the demand curve for individual stocks. An econometric approach is adopted that models the slope of the excess demand curve within an econometric framework using signed market maker transactions data between 1 August 1994 and 31 July 1995.FindingsThe findings confirm that the demand curves for individual stocks do slope downwards. For example, the mean estimated percentage fall in stock price caused by a new share issue that is 1 per cent of the existing number of outstanding shares is −5.6.Practical implicationsDownward sloping demand curves pose difficulties for theories in finance that rely on the law of one price and price‐takers in competitive markets. For example, the dividend policy and capital structure irrelevance theorems of corporate finance, and the efficient markets hypothesis assumption that the price of a stock is determined only by information about future cash flows and the discount rate are not consistent with a downward sloping demand curve.Originality/valueThe slope of the demand curve is estimated using an econometric model and market makers' transactions data for specific stocks. This approach identifies observable unexpected shifts in the demand for a stock as unexpected changes in market makers' inventories. This approach is superior to event studies because it provides multiple observations that enable the slope of the demand curve to be quantified with sufficient confidence to calculate the price elasticity of demand for the stock.