Determinants of Marshallian Demand for Financial Assets: Evidence from New Issues of Federal Home Loan Bank Debt

We estimate the slope of the Marshallian demand curve for newly auctioned FHLB discount notes and investigate the impacts of arbitrage risk and heterogeneity of beliefs on demand elasticity. Our dataset contains roughly 2,900 observations of two price-quantity pairs—the first from a pre-auction dealer survey, the second from actual auction results. Using this unique dataset, we find that demand for FHLB notes is highly elastic and negatively related to proxies for arbitrage risk and heterogeneity of investor beliefs. We show that for this low information asymmetry asset, a discriminatory price auction mechanism achieves near perfectly elastic demand during normal market conditions. We also document that demand elasticity drops by roughly 50% during the recent financial crisis. This drop is explained by contemporaneous increases in arbitrage risk and heterogeneity of beliefs.