6. Structure of Equity Prices

The World Federation of Exchanges Market Highlights (www.​world-exchanges.​org) reports that trading during 2014 on the world’s equity exchanges totalled $US81 trillion, while their capitalisation averaged $67 trillion.

Using US data, net acquisition of equities and non money market mutual funds averaged $400 billion per year during 2009–2014 (Board of Governors of Federal Reserve System, 2015: table F10), which is around 3% of equity markets’ turnover.

In a summary of US mutual fund traits, Chen, Desai and Krishnamurthy (2013) report their average annual turnover is 94% of assets.

Of course, rapid price moves can sometimes have an obvious cause such as a false report attributed to Associated Press on 23 April 2013 that President Obama had been injured in an explosion in the White House, which saw US financial markets drop by 2% for a minute or two.

www.​archive.​org/​details/​EconomicWarfare-RisksAndResponse​sByKevinD.​Freeman.

For an introduction to this extensive literature see Professor Kramer’s website www.​lisakramer.​com.

See Ekholm and Pasternack (2005) and Kee-Hong et al. (2006) for a discussion of equity skew. Harvey and Siddique (2000) discuss theoretical contribution of skew to asset prices.

An alternative perspective on the sawtooth pattern is the price pressure hypothesis where the price of a security rises (falls) in response to a large buy (sell) order to induce sellers (buyers) to accommodate the order; the price then returns to its earlier value (assuming the trade has no information content) to provide the inducement (Scholes 1972). A succession of such trades will generate a sawtooth pattern. For a discussion of mutual fund price pressure see Ben-Rephael et al. (2011).

Corporate fixed costs (SG&A) average around 25% of revenue (e.g. Weiss 2010). Conservatively assume a saving of 10% of combined SG&A, with pre-tax earnings equal to 15% of revenue and a 30% tax rate: this gives additional pre-tax revenue of 2.5% of revenue, which at a constant price:earnings ratio would justify a combined share price rise of one sixth.

For a summary of studies into factors affecting the cross-section of equity returns see Dai (2015).

My favourite example is the Super Bowl stock market predictor which says that if the Super Bowl (the championship of American football that was first played in 1967) is won by a team from the old National Football League then the US equity market will be up that year; and vice versa. After a string of successful predictions in the competition’s early years, the indicator was installed as a piece of market wisdom, secured further prominence in a 1978 column by New York Times sportswriter Leonard Koppetta, and featured in a Journal of Finance article which found it delivered a return double that of a buy-and-hold strategy (Krueger and Kennedy 1990). Although the Super Bowl predictor entered researchers’ quiver of market biases, a review covering the next two decades shows the predictor now almost exactly matches results of a buy and hold strategy (Kester 2010).