Share Price Formation, Market Exuberance and Accounting Design

Abstract

This paper develops a theoretical analysis of share market price formation driven by accounting and market structures. Interacting heterogeneous investors are assumed to discover and process fundamental information disclosed by accounting system of share-issuing entity. Information set available to share market investors for decision-making comprises then market-driven and firm-specific (non-market) information. From one side, accounting system provides collective signal of fundamental information; from another side, price system provides collective signal of market-driven information over time. Both jointly drive the formation of aggregate share market prices through limited knowledge, hazard, and social interaction. Numerical simulations are provided under alternative accounting regimes (namely, historical cost and fair accounting regimes), to derive implications and recommendations for the concept and occurrence of speculative bubbles and herd behavior; the cyclical effects of accounting regime on share market price dynamics; and the value relevance of accounting information and its role in the formation of share market prices over time.This numerical statistical analysis contributes to shed light on financial stability, market exuberance, accruals accounting anomalies and fundamental analysis.