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Exhibition: Why the equilibrium stock price is fluctuating Introduction: Click the links on or below the figure
for more information. The figure illustrates that when the cost of
estimating fundamental
corporate value is significant then the stock price needs to be
fluctuating around that value in order to provide incentives for informed
investors to enter the market. This is important, because without informed
investors the stock price would be arbitrary and unable to allocate
resources efficiently. Fortunately, this scenario would never come true
because in this case the informed investors would earn higher returns than the
uninformed. This is so because informed investors are more able to sell
stocks when they are overvalued and to buy when they are undervalued. On the
other hand, if the stock market were composed entirely of highly informed
investors the stock price would be equal to its true fundamental value.
Unfortunately, this would never happen, because in that case it would be
possible to make more money as an uninformed investor because the money spend
on estimating fundamental value could be saved. As a result of this dynamics
the long-term stock price fluctuates around its fundamental value with intensity
that makes all investment strategies (from the uninformed to the highly
informed) equally profitable. These ideas are fully consistent with those
presented by Grossman and Stiglitz [1976, 1980], and Cornell and Roll
[1981]. The first version of this illustration was made by H. Mathiesen
[1996, chapter 4]. Note: All bold text in figure below can
be clicked to obtain more information (If you can’t click
here). |
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- Copyright 1997-2010, ViamInvest. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Legal notice. |