Asset prices when large investors interact strategically

This paper examines equilibrium asset prices and leverage in an exchange economy populated with both retail and institutional investors. Institutional investors influence the price of the stocks they trade and are aware of the price impact of the opponent and, thus, interact strategically. Because of the price impact, institutional investors decrease their demand for stocks and lend money to the retail sector, thereby increasing leverage in the economy. The risk-free rate (equity premium) tends to be lower (higher) as compared to an economy populated by retail investors only. Retail investors' compensation for liquidity provision depends on the behavior of institutional investors and the state of the economy.