What is the demand elasticity of statistical arbitrageurs that invest according to the advice of modern cross-sectional asset pricing models? Thirteen models from the literature exhibit strikingly inelastic demand, in contrast to classical models that rely on statistical arbitrageurs to create elastic market demand for assets. This inelasticity arises from the difficulty of trading against price changes. A quantitative equilibrium model shows that aggregate demand remains inelastic even with these statistical arbitrageurs in the market.

Classical asset pricing models predict that optimizing investors exhibit extremely high demand elasticities, while empirical estimates are significantly lower—by three orders of magnitude. To reconcile this disparity, we introduce a novel decomposition of investor demand elasticity into two key components: “price pass-through”, which captures how price movements forecast returns, and “unspanned returns”, reflecting a stock’s lack of perfect substitutes. In a factor model framework, we show that unspanned returns become significant when models include “weak factors”. Classical models overestimate demand elasticity by assuming both very low unspanned returns and high price pass-throughs, assumptions that are inconsistent with empirical evidence.