Complex Asset Markets

Complex Asset Markets

By Andrea L. Eisdeldt, Hanno Lustig, Lei Zhang
May 23,2017Working Paper No. 3533

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 this asset market’s risk bearing capacity. Higher expert demand lowers equilibrium required returns, reducing overall participation. In a dynamic industry equilibrium, investor participation in more complex asset markets with more asset-specific risk is lower, despite higher market-level Sharpe ratios, as long as asset complexity and expertise are complements. We analyze how asset complexity affects the stationary wealth distribution of complex asset investors. Because of selection, increased complexity reduces expertise heterogeneity and wealth concentration, even though the wealth distribution for more expert investors has fatter tails.

Previously titled Risk and Return in Segmented Markets with Expertise

Keywords
heterogeneous agent models, industry equilibrium, firm size distribution, segmented markets, limits of arbitrage