ELasticity of demand

[shanlane]

Hello,

Am I crazy or does Dowd define the elasticity of demand incorrectly? Everywhere I look, elasticity of demand is the % change in demand due to a change in price. He defines it as the % change in price due to the change in demand. Yet another consistency issue we have to deal with. Garp really has to get their act together.

Thanks!

Shannon

 

[David Harper CFA FRM]

Hi Shannon,

I do agree that in economics the own-price demand elasticity is, by convention (dQ/Q)/(dP/P) rather than Dowd's usage. (I happen to know it since I am fresh from writing CFP questions on demand elasticity, that included CFA validation; e.g., http://forum.bionicturtle.com/threads/1-6-demand-curves.5383/)

However, quants like Dowd do this often knowingly, negate or invert (use the reciprocal) definitions when it suits the purpose and it's only really "semantic." In Dowd's case, it even makes sense:

• it makes his LVaR a notch easier on the eye; using eta instead of 1/eta
• more importantly, in my opinion, it's more natural: whereas conventional econ treats quantity demanded as reacting to the price change (such that dQ/dP sort of treats Quantity as the dependent), liquidity risk reverses this! dP/dQ is more like price is the dependent reacting to quantity as the independent. I hope that's interesting!

 

[shanlane]

Agreed that it is interesting and useful, but calling eta "elasticity of demand" when the common formula for "elasticity of demand" is its reciporical is just a bit on the confusing side.

Thanks again for all of the help!

Shannon