So, the 'value' of owning stock is the expectation that, through some means or other, the company will return a profit to its shareholders at some point in the future. Of course, expectations about that future vary quite a bit among investors, so it's also *speculative*. If you buy a share of XYZ at $10 and sell it at $20 to another investor rather than to XYZ itself in a buyback, then your $10 profit came from that investor minus what went to whoever you originally bought it from. If at some point in the future XYZ buys it from her at $30, then you, in effect, bet that it would go up to $20 and won, but not higher and lost. On the other hand, if the day after you sell a zombie plague breaks out in XYZ's main office (or any other unexpected disaster) and the person who bought it from you is stuck with a worthless share, then in effect you won your bet.
Whatever XYZ does that makes it a profit is presumably actually creating value directly, but in one sense that sort of speculation is zero sum, and if the 'noise' of speculation overwhelms the 'signal' of the company actually returning profit to its investors, you end up with distortions. I think a good conceptual model is that investment markets are a sort of non-linear amplifier, where the input signal is the actual peformance of the companies being traded and well-considered, independently formed expectations of their future performance, but there's also a lot of feedback in the form of 'herd behavior' by investors copying strategies that look successful for others - i.e., buying a stock because it's been going up in the past rather than because you have a good reason to believe it's undervalued by the market. Like an audio amplifier, it can have a sort of crossover point where on one side the signal is dominant, and on the other feedback takes over and the output is determined by internal properties of the amplifier itself rather than by the input. The equivalent in financial markets is a speculative bubble.
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timeasmymeasure
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Date: 2010-04-03 11:22 pm (UTC)So, the 'value' of owning stock is the expectation that, through some means or other, the company will return a profit to its shareholders at some point in the future. Of course, expectations about that future vary quite a bit among investors, so it's also *speculative*. If you buy a share of XYZ at $10 and sell it at $20 to another investor rather than to XYZ itself in a buyback, then your $10 profit came from that investor minus what went to whoever you originally bought it from. If at some point in the future XYZ buys it from her at $30, then you, in effect, bet that it would go up to $20 and won, but not higher and lost. On the other hand, if the day after you sell a zombie plague breaks out in XYZ's main office (or any other unexpected disaster) and the person who bought it from you is stuck with a worthless share, then in effect you won your bet.
Whatever XYZ does that makes it a profit is presumably actually creating value directly, but in one sense that sort of speculation is zero sum, and if the 'noise' of speculation overwhelms the 'signal' of the company actually returning profit to its investors, you end up with distortions. I think a good conceptual model is that investment markets are a sort of non-linear amplifier, where the input signal is the actual peformance of the companies being traded and well-considered, independently formed expectations of their future performance, but there's also a lot of feedback in the form of 'herd behavior' by investors copying strategies that look successful for others - i.e., buying a stock because it's been going up in the past rather than because you have a good reason to believe it's undervalued by the market. Like an audio amplifier, it can have a sort of crossover point where on one side the signal is dominant, and on the other feedback takes over and the output is determined by internal properties of the amplifier itself rather than by the input. The equivalent in financial markets is a speculative bubble.