January 8, 2014
Why would someone buy stock?
- Performance (price might go up), investment/speculation -> R
- Diversification -> R
- Hedging against inflation -> R
- Control (eg. Board membership)
- Lower commission than other investment opportunities
- Support your favourite company, public relations
- (liquidity) trading time very short
- Reduce number of shares on the market (for accounting reasons)
- Other benefits of ownership (eg. Discounts, getting financial reports, voting rights,
attending shareholder meetings)
- *Cover another trade -> R + bad luck
- Mistake (eg. TWTRQ)
R – rational investor model
Irrational buyers pay outside the bid-ask spread and drive the market
Covering a trade: A promises to be able to deliver 100,000 shares to B (probably b/c of option).
A hopes it will not have to deliver, but if A must deliver and doesn’t already own the stock, A
buys to cover.
What assumptions weaken our theory?
- No commission/transaction cost
- Existence/availability of risk-free rate
- No arbitrage
- Unlimited supply of stock (market shortage, liquidity, market volume)
- Risk-averse investor (minimize risk)
- Transaction does not affect market price
- Constant interest rate
- Investor profile not diverse
- No inflation
- No tax - EMH (efficient market hypothesis)