Rethinking Asset Existence
From Risk Compensation to Capital Dominance
1 Conventional View
Financial Assets as Risk-Reward Instruments
In classical asset pricing theory, financial assets are presumed to exist to reward investors for bearing risk. Through mechanisms such as arbitrage and diversification, idiosyncratic risk is mitigated, and equilibrium returns are determined by each asset’s exposure to systematic risk. This framework justifies the existence of any asset through the promise of a fair, risk-adjusted return. Asset prices thus reflect not market power or concentration, but the compensated cost of risk.
This view embeds a philosophical logic of fairness: that market participants are compensated proportionally for risk undertaken, and that capital flows dynamically toward efficiency. Such a model assumes fluid reallocations, reversibility of state transitions, and the dominance of fundamentals over flow mechanics.
2 TBTF View
Financial Assets as Power-Concentrating Instruments
In contrast, the TBTF framework rejects this equilibrium-based justification. It posits that some financial assets (especially in the public secondary market) persist not because of their risk-return characteristics, but because they are capital sinks—entities with entrenched market dominance, self-reinforcing narratives, and structural insulation from volatility.
These assets do not compensate for uncertainty—they absorb uncertainty by offering investors a sense of safety rooted in scale, liquidity, and systemic centrality. TBTF assets act as narrative anchors in uncertain markets: not because they offer greater upside, but because they symbolize continuity, legitimacy, and collective default.
This redefines the rationale for capital allocation: from (short-run) return-maximization to (long-run) structure-maximization. Investors increasingly allocate not to “the best opportunities” in the short-term, but to “the safest dominant incumbents” in the long-term. The performance of TBTF strategies arises not from myopic risk pricing, but from farsighted market structure engineering—index inclusion, ETF flows, regulatory inertia, and the psychology of too-big-to-fail.
3 Philosophical and Mathematical Justification
This philosophical inversion has deep implications:
- Existential Justification: Financial assets exist not to reward risk-takers but to retain power. Their performance is a function of initial endowment, not market responsiveness.
- Statistical Structure: The return-generating process resembles a non-ergodic, non-reversible Markov chain, where top and exit states become quasi-absorbing.
- Mathematical Inertia: TBTF assets exhibit relative second-moment stationarity, even when first moments shift. This aligns with the capital inertia hypothesis: relative structure is stable, absolute returns are residual.
- Narrative Economics: Echoing Shiller and Gennaioli–Shleifer, capital allocation is driven less by fundamentals than by narratives of dominance, size, and safety.
4 Implication for Market Theory
The TBTF perspective challenges the canonical assumptions of:
- Arbitrage efficiency: capital does not equalize returns across assets
- Risk-reward equilibrium: structural power trumps systematic beta
- Dynamic reallocation: capital flows become locked, not optimized
- Allocative neutrality: flow-based reinforcements create concentration spirals
In this view, financial markets do not price risk—they price dominance. The empirical success of TBTF strategies is not an anomaly; it is a manifestation of long-term structural inertia, capital path dependence, and the self-fulfilling logic of institutional safety.