Market #4 · Equities

The stock & equity market

Parallel to the labor, goods, and bond modules: determinants of equity demand and supply, valuation equations (DDM, DCF, RIM, multiples, Campbell–Shiller), asset-pricing models (CAPM through q-factor and APT), option pricing and Greeks, mean-variance optimization, and real-world applications.

Market clearing in price space

Q^{D} (P; X^{D}) = Q^{S} (P; X^{S}) \Rightarrow P^{*}

Passive / retirement / foreign flows and buybacks make aggregate equity demand highly inelastic (Gabaix–Koijen 2022): a $1 shift in demand moves market cap by ≈ $5–7, an order of magnitude larger than classical textbook models predicted.

Demand shift (flows, sentiment)

Supply shift (IPO/SEO minus buybacks)

Structural demand & supply

Q_{t}^{D} = f (E [r_{e}], r_{f}, E R P, σ_{m}, γ, W, π^{e}, F, S, P^{in d e x}, T, R, L)

Q_{t}^{S} = g (I P O, S E O, M & A, B B, Div, P E, V, L^{cor p}, τ^{c}, Reg, ESG)

Signs, data sources, and rationales below.

Equity-demand determinants

Symbol	Variable	Data source	Sign	Economic rationale
$E [r_{e}]$	Expected equity return	Consensus IBES / SPF / SVAR	+	Higher expected return raises portfolio share (Merton 1971 optimal allocation).
$r_{f}$	Risk-free rate	Fed H.15, ECB €STR	−	Substitute yield: cash / T-bills compete with equities for allocations.
$E R P$	Equity-risk premium	Damodaran; Duarte–Rosa (NY Fed 2015)	+	Compensation for systematic risk; drives strategic allocations.
$σ_{m}$	Market volatility	VIX / realized vol	−	Mean-variance investors reduce equity share when σ² rises (Merton–ICAPM).
$γ$	Risk aversion	Household surveys; SCF	−	Higher γ → lower equity share (Merton rule w* = (μ−r_f)/(γσ²)).
$W$	Household wealth	Fed Flow of Funds Z.1	+	Life-cycle: wealth expansion raises equity holdings, especially past retirement threshold.
$π^{e}$	Expected inflation	TIPS breakevens, SPF	±	Modigliani–Cohn inflation illusion; empirically negative correlation with P/E.
$F$	Foreign / global flows	IIF, EPFR, TIC	+	Cross-border allocation shifts drive local demand (e.g., US mega-cap flows post-2015).
$S$	Sentiment / attention	AAII, Google Trends, Baker–Wurgler	+	Behavioural demand shifter; large short-run effect on small-cap / meme stocks.
$P^{in d e x}$	Passive / index demand	ICI, Bloomberg ETF flows	+	Inelastic demand from index funds (Gabaix–Koijen 2022 inelastic market hypothesis).
$T$	Tax treatment of dividends / gains	IRS, OECD tax database	±	Lower cap-gains / qualified-div tax raises after-tax return; alters demand for high-div stocks.
$R$	Retirement contribution flows	DoL 5500, ICI	+	401(k)/IRA/DC plan contributions are structural buy-side demand.
$L$	Leverage / margin capacity	FINRA margin debt	+	Broker margin fuels demand at high multiples; forced deleveraging on drawdowns (Adrian–Shin 2010).

Equity-supply determinants

Symbol	Variable	Data source	Sign	Economic rationale
$I P O$	New issuance / IPO activity	Renaissance Capital, SDC	+	Primary supply expands the equity float; IPO windows are procyclical (Lowry 2003).
$S E O$	Seasoned equity offerings	SDC, Bloomberg SEO	+	Firms exploit high valuations (market-timing theory, Baker–Wurgler 2002).
$M & A$	Stock-for-stock M&A	Dealogic, LSEG	+	New shares issued to acquire targets; enlarges float.
$B B$	Buybacks / share repurchases	S&P Buyback Index, 10-Qs	−	Retires shares; largest net-supply reducer in post-2008 US equity market.
$Div$	Dividend policy	S&P Div Yield, ISS	±	Higher payout attracts income investors, alters clientele mix (Miller–Modigliani 1961).
$P E$	Private-equity / take-private activity	PitchBook, Preqin	−	LBOs remove companies from the public float.
$V$	Venture / late-stage private capital	PitchBook, NVCA	−	Delays IPOs; keeps supply private for longer (Ewens–Farre-Mensa 2020).
$L^{cor p}$	Corporate leverage capacity	S&P Global Ratings	±	Higher optimal debt shifts capital structure toward debt, reducing equity issuance.
$τ^{c}$	Corporate tax rate	OECD tax database	±	Higher τ makes debt-tax shield relatively more valuable, reducing equity share.
$R e g$	Regulation (listing, disclosure)	SEC, ESMA	−	Sarbanes–Oxley / MiFID II raised listing costs, contributing to public-market shrinkage.
$ESG$	ESG / dual-class governance	ISS, MSCI ESG	±	Governance changes affect issuance mix and investor eligibility.