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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 1997-2008, ViamInvest. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Legal notice. |