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Terminology: Three cases of stock price fluctuations The three cases of stock price fluctuations are: 1) Equilibrium stock price fluctuations. 2) Disequilibrium (excessive) stock price
fluctuations. 3) Disequilibrium
(understated) stock price fluctuations. The terminology is used in the following exhibitions about stock price
theory
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This particular stock theory explains how the stock price
of a large, publicly held corporation is determined in times without changes
in corporate control and without speculation. The central idea is that the
stock price is determined by some weighted average of investment acts from
investors applying informational diversified investment strategies. The dynamics behind the price
fluctuation is as follows: The higher the share of uninformed investors, the
more uncertain the market price is relative to the fundamental stock value.
This compares to larger fluctuations around this fundamental value and/or
more frequent fluctuations. The picture is reversed when the share of
informed investors increase and/or this share become better informed. In the
exhibition the fluctuations are smooth. However, this needs not be the case.
The fluctuation may be much more irregular. One should remember that the
advantage of being an informed investor is to be more able to buy cheap and
sell expensive because they have a better idea about the fundamental value of
the stock. It should be obvious that this advantage increases the more the
actual stock price fluctuates around the fundamental stock value. Altogether, this suggests that there exist
an equilibrium stock price associated with a particular level of fluctuations
around the true stock value. The text below explains that this
equilibrium level of price fluctuations is restored if it is disrupted for
some reason. Two cases must be considered; one with excessive fluctuation and one with understated fluctuation. |
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Imagine that the market price for some reason begins to
fluctuate more than its equilibrium level. This is illustrated in the exhibition by the large swings.
This implies that the informed investors start earning abnormally high
returns on their investments because the average benefits from being informed
increases and the average cost of being informed remains the same.
Furthermore, the uninformed investors bear the full burden of the higher risk
following higher degrees of fluctuations, and they face lower mean returns
because the higher returns the informed investors are making have to come
from lower returns made by the uninformed investors. The higher risk does not
hit the informed investors equally hard because they are more able to buy
when the price is low and sell when it is high. They are therefore able to
avoid some of the negative risk while maintaining most of the positive risk.
Therefore as time passes, some investors discover that it pays to pursue
informed investment strategies and the share of informed investors starts to
increase. This mechanism restores the equilibrium fluctuation level. |
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Consider the situation where the market price starts to
fluctuate less than the equilibrium level. This situation is illustrated by
the small waves in the exhibition.
In this case, the benefit from being an informed investor fall but the cost
remains the same so that informed investors begin to earn abnormally low
profits. At the same time the uninformed investors benefit from the reduced
risk that follows less fluctuations. This benefit is larger than the benefit
that accrues to informed investors because the latter already has an
advantage in handling risk (see above). The result is that the share of
uninformed investors begins to rise at the expense of informed investors, and
this process restores the equilibrium level of price fluctuations. |
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- Copyright 1997-2008, ViamInvest. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Legal notice. |
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