Working Paper: NBER ID: w23476
Authors: Andrea L. Eisfeldt; Hanno Lustig; Lei Zhang
Abstract: We develop a dynamic equilibrium model of complex asset markets with endogenous entry and exit in which the investment technology of investors with more expertise is subject to less asset-specific risk. The joint equilibrium distribution of financial expertise and wealth then determines risk bearing capacity. Higher expert demand lowers equilibrium required returns, reducing overall participation. In equilibrium, investor participation in more complex asset markets with more asset-specific risk is lower, despite higher market- level Sharpe ratios, provided that asset complexity and expertise are complementary. We analyze how asset complexity affects the stationary wealth distribution of complex asset investors. Because of selection, increased asset complexity reduces wealth concentration, even though the wealth distribution for more expert investors has fatter tails.
Keywords: complex asset markets; investment technology; financial expertise; risk-bearing capacity
JEL Codes: G12; J42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher levels of expertise among investors (G11) | lower required return on complex assets (G19) |
| expertise (D80) | reduced asset-specific volatility (G19) |
| reduced asset-specific volatility (G19) | increased risk-bearing capacity of investors (G31) |
| increased asset complexity (G32) | decline in market participation among less expert investors (G41) |
| expertise (D80) | exclusion of lower expertise investors from participating in more complex assets (G19) |
| increased asset complexity (G32) | less concentrated wealth distribution among investors (D39) |
| relationship between expertise and asset complexity (D80) | market dynamics (D49) |