Theory Of Price Formation Research Articles

A Theory of Price Formation in Financial Markets

A Theory of Price Formation in Financial Markets

Transcending the Schumpeter-Kirzner Dichotomy: The Role of the Entrepreneur in Carl Menger’s Theory of Price

What is the role of the entrepreneur in Carl Menger’s account of the market process? Modern entrepreneurship theory is broadly divided into two types. The Schumpeterian account of entrepreneurship takes an equilibrium state of affairs as an analytic starting point from which the entrepreneur disrupts the existing equilibrium through technological innovation. The Kirznerian account of entrepreneurship begins from disequilibrium to illustrate the equilibrating role of the entrepreneur through arbitrage. While some working within the Austrian tradition have found Menger’s account to be lacking in precisely the entrepreneurial role that would become a distinctive contribution of the school, we demonstrate that Menger implicitly accounts for entrepreneurship in his theory of price formation. In doing so, we argue that Carl Menger’s account of entrepreneurship transcends the distinction between the Kirznerian and Schumpeterian entrepreneur by incorporating not only price adjusting behavior (i.e. arbitrage) but also non-price adjusting behavior (i.e. product differentiation; variations in quantity and quality; institutional innovation). To the extent that Schumpeterian and Kirznerian entrepreneurship are distinct categories in the history of economic thought, we show how both have roots in the pioneering efforts of Carl Menger, the founder of the Austrian School.

On the Exposition of the Transformation of Commodity-Values into Production Prices in the Third Volume of <i>Capital</i>—A Textual Analysis

The article is about the exposition of the Karl Marx’s concept of production prices in his main work Capital. It focuses on the structure of the central text in question, Chapter 9 of the third volume, on “transformation [Verwandlung] of commodity-values into production prices”. The actual content and structure of the chapter has to some degree been overlooked or distorted in the literature. The aim of the article is to establish (or re-establish) a sound view of the chapter, freed from prejudices nurtured by—especially—a theory of price formation which, albeit “modernized” by i.a. Walras, dates back to Steuart and Ricardo. These prejudices have had an immense significance for misunderstandings of the Marxian theory of measure of value and standard of prices reflected in the text of the chapter mentioned. For this reason, the article is furnished with an Appendix, underlining the difficult situation for Marxist-minded research today. It should be noted that it is not an objective of the article to discuss any extant interpretation of Marx’s exposition. However, the paradigm of criticism that was introduced early in the 20th century by Ladislaus von Bortkiewicz is used as a perspective. Specific references—other than to Marx’s own texts—are held at a minimum in the article proper. I have chosen such a mode of approach because I find that misunderstandings of the chapter are evenly distributed among authors regardless of how their views on the “transformation” collide. On the other hand, such a consciousness of “misunderstandings” among commentators certainly does imply that the author should at least shortly clarify his own view of the main problems in the paradigmatic criticism mentioned above. In the first section, I point out the importance of Marx’s way of presenting his concept of the composition of capital. In the next, I make some remarks on the concept of the socially necessary labour time and its relation to abstract labour. In the third and fourth, I investigate Marx’s different models of analysis. In the fifth section, it will be shown how Marx, contrary to contentions of traditional criticism, but in harmony with his treatment of the capital composition and necessary labour time, is operating with a double point of departure: He treats the inputs of a production period as given as values, i.e. as individual use value-entities; paralleling this, he treats them as transformed to production prices. There follows a sixth section, where I point out the core of the critique that Bortkiewicz presented of the chapter, focusing on the need for a uniform expression of economic denominations. Since Bortkiewicz’s criticism contained all the important germs to the objections against Marx refuted in my article, this section also serves to spread light over the rest of my argument. After the overview mentioned above, I round off with a summary.

Asset Allocation and Security Selection in Theory & in Practice: A Literature Survey from a Practitioner’s Perspective

Whether for the sake of trying to make a fortune or for the sake of knowledge, both practitioners and academicians have had interests in studying the behavior of financial time series data since the existence of financial markets. Academicians contributed equilibrium models that aim to describe the process of price formation in capital markets. Over time, two schools of thoughts were established: the efficient markets school and the behavioral finance school. Proponents of the former believed in the Efficient Markets Hypothesis (EMH), whereas the latter brought evidence from behavioral finance and neurosciences showing that investors, especially retail traders, exhibit irrational behavior, which can explain the observed violations of the EMH in financial markets. Practitioners were not interested in developing models of price formation; rather they were interested in developing techniques to analyze and predict the price movements of financial assets. Same as academicians, practitioners can also be grouped into two schools of thought: the fundamental analysis school and the technical analysis school. Although both schools of thought share the same objective, which is to give advice on what and when to buy and sell assets for the sake of making profit, they differ in their ways of analysis. The significant role played by academicians and practitioners in the finance industry and the interconnection between both schools and the approaches followed within each of them are best perceived in the way financial assets are allocated and portfolios are constructed. In an attempt to cross that bridge between the theory of price formation in financial markets and its practical implementations, this paper aims to survey the literature on both the theoretical and the practical frontiers of asset allocation and portfolio construction, and the best way of carrying on this task is through a thorough description of the portfolio management process (PMP). To this end, the paper breaks the PMP into three main steps, namely, portfolio planning, portfolio construction, and portfolio evaluation, in that order, and then discusses each step while surveying the literature pertaining to it. In addition to the description of the PMP, the paper also answers questions of particular interest to young practitioners, who are taking their first steps towards a career in the finance industry, such as: How portfolio theory, which is at the core of finance theory, is applied in practice? How a financial portfolio of assets is constructed in practice? How the individual assets forming a portfolio are selected and allocated? And is the process of constructing portfolios unique? Although the answers to these questions might appear to be simple and straightforward, they are, in fact, quite complicated. The complication lies not only in making the theory, which is based on certain restrictive and unrealistic assumptions, work in practice, but also in the simultaneous use of a variety of tools and financial concepts in forming a sound investment strategy.

Adam Smith and Modern Economics.

In his Wealth of Nations (1776) Adam Smith created an agenda for the study of the economy that is reflected in the structure of modern economics. This paper describes Smith’s contributions to four central areas of economic theory: The theory of price formation, the relationship between market outcomes and the public interest, the role of the state in the economy, and the sources of economic growth. In each case, an attempt is made to relate Smith’s contribution to the state of contemporary economics, showing both the similarities and contrasts between the respective approaches.

What Does Equity Sector Orderflow Tell Us About the Economy?

Investors rebalance their portfolios as their views about expected returns and risk change. We use empirical measures of portfolio rebalancing to back out investors' views, specifically, their views about the state of the economy. We show that aggregate portfolio rebalancing across equity sectors is consistent with sector rotation, an investment strategy that exploits perceived differences in the relative performance of sectors at different stages of the business cycle. The empirical footprint of sector rotation has predictive power for the evolution of the economy and future bond market returns, even after controlling for relative sector returns. Contrary to many theories of price formation, trading activity, therefore, contains information that is not entirely revealed by resulting relative price changes.

What Does Equity Sector Orderflow Tell Us About the Economy?

Investors rebalance their portfolios as their views about expected returns and risk change. We use empirical measures of portfolio rebalancing to back out investors views, specifically views about the state of the economy. We show that aggregate portfolio rebalancing across equity sectors is consistent with sector rotation, an investment strategy that exploits perceived differences in the relative performance of sectors at different stages of the business cycle. The empirical foot-print of sector rotation has predictive power for the evolution of the economy, future stock market returns, and future bond market returns, even after controlling for relative sector returns. Contrary to many theories of price formation, trading activity therefore contains information that is not entirely revealed by resulting relative price changes.

Discussion of “Competing Theories of Financial Anomalies”

[Efficient markets and asset pricing] research ... did not begin with the development of a theory of price formation which was then subjected to empirical tests. Rather, the impetus ... came from the accumulation of evidence ... that the behavior ... of speculative prices could be well approximated by a random walk ... Faced with the evidence, economists felt compelled to offer some rationalization .... In short, there existed a large body of empirical results in search of a rigorous theory.

Some microfoundations of Austrian economics: Böhm-Bawerk's version

This paper investigates Boohm-Bawerk's version of Austrian microeconomics. It draws some comparisons with Carl Menger's programmatic work on the principles of economic theory which originally established a distinctive Austrian tradition. Bohm-Bawerk's microeconomics is also considered against the background of contemporary Walrasian, Edgeworthian and Marshallian thought as well as twentieth-century work on the theory of games. Bohm-Bawerk offers a theory of micro-structural dynamics. His emphasis on intentionality and imagination in value creation, the scope for bargaining and strategic behaviour in his theory of markets and the avowed indeterminacies and equilibrating tendencies in his theory of price formation, are all consistent with other first-generation Austraian contributions. There is nothing especially Walrasian or Marshallian about Bohm-Bawer's. microeconomics

Carl Menger's Theory of Price Formation Reconsidered

Carl Menger's Theory of Price Formation Reconsidered

Terms of trade and class conflict in a computable general equilibrium model for Mexico

A computable general equilibrium model for Mexico is constructed in which class conflict over the distribution of the surplus is the principal determinant of the terms of trade. The model consists of seven social classes and eight productive sectors. Classes are distinguished as ‘fundamental’ or ‘subsumed’ according to whether their incomes are primarily determined by conscious class struggle or by the resulting system of relative prices. Flexible prices are assumed to clear markets for which non‐produced means of production, such as agricultural land, limit supply while output in the remaining sectors is determined by the level of effective demand. For the latter sectors, two theories of price formation are compared and are seen to differ radically in their implicit conception of the nature of class conflict. A ‘Keynes‐Kalecki’ closure is considered in which prices are determined by a fixed mark‐up on costs. This enables capitalists to protect themselves from incursions on the rate of profit due to labour militancy or state‐imposed terms‐of‐trade policy designed to favour peasants andlor the agrarian bourgeoisie. A second, ‘Marx‐Sraffian’ price closure constrains the economy to a wage‐profit‐terms‐of‐trade surface; where the economy conjuncturally resides on this surface depends upon the level of effective demand, wages and terms‐of‐trade policy. Various policy scenarios are investigated under both closures.

Marginal and Average Values in the Theory of Price Formation

Whether to establish prices in a socialist economy at the level of average expenditures of labor or whether to give preference to marginal expenditures of labor, i.e., expenditures of labor at the worst enterprises (1), is a problem that economists have already debated for a long time.

Experimental Evidence on Price Formation in Competitive Markets

Standard theory of price formation in perfectly competitive markets contends that buyers and sellers bargain and recontract until the price is reached at which the quantity offered for sale is equal to the quantity demanded.1 All contracts are then made at the equilibrium price which is the only price observed in the market. Three important differences between the model and actual markets are that the latter operate under sequential binding contracts which are made at discrete points in time with imperfect information. These differences raise several questions concerning the extent to which prices and quantities observed in real markets reflect the theoretical equilibrium price given by the underlying market supply-and-demand curves in force at the opening of the market. The first of these questions is whether the average observed price is equal, in a statistical sense, to the theoretical equilibrium price. Ignorance on the part of the buyers and sellers as to the true equilibrium price and the shifting of market supply-and-demand curves as buyers and sellers make contracts and leave the market are both factors allowing for discrepancies between actual and theoretical equilibrium prices. Presumably, in the case of perfect information by all participants, all transactions are made at the equilibrium price. This is because buyers would be unwilling to pay a higher price and sellers to accept a lower one. On the other hand, in the presence of incomplete information, Lancaster (1969, p. 42) suggests that, if the actual price is above the equilibrium price, some sellers sensing that the price is too high will quickly lower their prices but not to the equilibrium price, make their sale, and leave the market. This argument from the buyer's side describes behavior below the equilibrium price, so that it is possible for actual prices to be dispersed about their theoretical value. When these more astute buyers and sellers leave the market, the market supply-and-demand curves shift to the left. However, they need not shift by the same amount so that a new theoretical price is defined. The market may then converge on this changed equilibrium price, resulting in an aver-

The Theory of Price Formation in Communist China

The theory of price formation has been vigorously discussed in Communist China since 1953, but the main themes of the discussion have varied. Generally speaking, the discussion may be conveniently divided into two periods. The first period covers the years prior to 1960, during which there were a large number of articles dealing with the role of the “law of value” in socialist planning and the problem of price formation for producer goods transferred within the state sector. The discussion was partly a result of Stalin's publication ofEconomic Problems of Socialism in the U.S.S.R.A number of Chinese economists disagreed with Stalin's assertion that the law of value and the concept of commodity production and exchange did not apply to the state sector.