--- Alypius Skinner <[EMAIL PROTECTED]> wrote: > If prices really are going up for a period of time > solely on expectation that someone else will always be willing to pay > prices even more unjustified by business fundamentals than the price the > previous buyer paid, then it would be possible to predict that the > overbid stocks will inevitably move downward by a large amount.
Yes, but: 1) Speculators often do not realize the market is a bubble. Prices are based on expectations of future demand, and that demand depends on future profits and other factors. For example, why is Amazon stock selling at a positive price, when it has been a "river of no returns"? Many share owners expect the company to make a profit in the future, or that the company will be sold at a higher price. That may never happen, but nobody knows for sure. People can expect higher future profits, and ex post this will seem unrealistic, but ex ante, nobody knows. It's not really greed, but hope, that creates momentum. 2) Many traders follow the trend. Trends can continue for a long time. So even though traders know the trend will peak out, nobody knows when, so traders keep buying. The problem is that the trend is not a straight line, but jagged, so nobody knows when a downturn is the major one or a temporary one. Markets can be efficient all the way up the trend and down the trend, because at each time and price, traders are using the available information. The problem is that nobody knows the future. Also, financial markets are not completely efficient, as knowledge has a cost, so it is sometimes possible to profit from knowledge even if it is publicly available. > If that is what you mean by an "efficient market" then to say that securities markets are efficient becomes a tautology rather than a theory.< If markets were not efficient, prices would not reflect yields and discount rates and competition. But they do tend to do so. So they are efficient, though not perfectly so. For example, if I want to buy an ounce of gold, I am not likely to find someone who will sell it to me at $200, and few would pay $400. The fact that most are buying and selling at a prevailing market price at some moment implies efficiency about the transmittal of information, about competition, and profit maximization. If the gold market were inefficient, we would see gold trading at widely different prices at the same time. But we don't see that. Over the long run and for most securities, returns tend to equalize relative to risk. > So are you saying that the market pricing of some stocks are efficient, > but not the pricing of others? No. I am saying that, ex post, resources are wasted in a company that went broke. But ex ante, investors and speculators don't know the future, and efficiency has to be looked at ex ante, where decisions are made. Also, a rise and fall in prices, by itself, does not imply economic inefficiency. At any price, funds are exchanged for assets. One person's gain is another's loss, and there is no net damage to the economy. Fred Foldvary ===== [EMAIL PROTECTED]
