1. Price theory and the price of equities – preliminary issues Robert W Vivian Professor of Finance and Insurance School of Economic and Business Sciences University of the Witwatersrand Presented at the 18 th Annual Conference of the South African Finance Association Cape Town, 13 th January 2009

2. Introduction The point of departure of most commentators is general economic theory vide Michael Coulsons positive reaction to Chriso and James paper on IPOs in the Investment Analysts Journal Genesis of this paper: Seen from an economics perspective, inaccurate statements in finance dissertations Theory of Finance has it origins in Economic theory – After all, most of the original fathers of modern finance theory were became Nobel Laureates in Economics – Indeed most would describe themselves as Economists With the passing of time (a mere 50 years) Finance Theory can take on a life of its own, and become divorced from economic theory

3. Price; in economic theory An important aspect of the theory of finance is to determine the price of equities (whatever that may mean); eg Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT) A central economic enquiry is the question of price – Adam Smiths value in use and value in exchange – David Ricardos continuation of the this question – Karl Marxs labour theory of value The price theory has been a central aspect of economics The intention of this research was to re-contexualise many of the main finance theories within the economic theory framework Useful for post-graduate students in finance Economic history of finance theories and doctrines. The initial academic thrust was after-all economists explaining finance phenomena

4. Articles on price theory and equities A small contribution of the application of economics to stock prices – Helen Makower (LSE) and Jocob Marshak (Chicago) Assets, prices and monetary theory Economica 1938 – Kenneth Boulding A Liquidity preference theory of market prices Economica 1944 From articles to textbooks... the picture changes

5. Price theory George J Stigler The Theory of Price (1-1942; 2-1946; 3- 1953; 4-1966;5-) Stigler and Boulding Readings in Price Theory AEA 1953 Donald Watson Reading in Price Theory 1963 Watson and Getz Price Theory and its uses 1963; 1968; 1972; 1977; 1981 Milton Friedman Price Theory 1-1962;2-1976 David D Friedman Price Theory 1986; 1990 Donald (as he then was) McCloskey The Applied Theory of Price 1989 J Hirshleifer The Theory of Price and applications However....

6. Conclusion – economics and price theory A study of these famous works on the theory of price indicates that they in fact have very little to do with the theory of price per se. It seems as if years ago they started off trying to explain prices, forgot what they were trying to do, and ended up writing general texts on economics; probably more useful Price theory not the theory of prices but microeconomics textbooks as reflected in the more recent names given to these textbooks

7. Thus... Things have not turned out as I had hoped; It was not as simple as I hoped Economic theory of price not set-out in such a way as to allow the holistic systematic exposition within to finance theory Hence the addition to the title - preliminary issues

8. What is Economics? These broad definitions are not particularly useful Hicks -Economics the study of the allocation of scarce resources – Difficult to see the direct significance within the finance context; Milton Friedman Economics is the science of how a particular society solves its economic problems reflecting the broader scope of his Price Theory book Alfred Marshall; Economics is A study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of material requisites of well- being.

9. A new definition of economics First thing then, we need a better definition of economics: – Vivian : The purpose of economics is explain economic phenomena. – A phenomenon is something we can perceive or observe Second thing we need a to understand what is a price – The most common economic known to man is the phenomenon of the transaction of exchange (Adam Smith) – One party exchanges, usually goods or services with other, for something valued in money units – The quantum or value of the money in a transaction of exchange is the price

10. Observations concerning price Price is what one actually pays (or paid) and another actually accepts (or accepted) It is not the prediction of what one may pay and another may accept in the future; What one does pay in the future is the price; – Oh dear movement of future indeterminate prices included in the current income statement – what a disaster Price is not an estimate of what we believe people should pay Price is to be found mainly in human behaviour not physics The price of gold or diamonds (and some modern forms of securities) is to be found in human beliefs. These have a price and maintain their price because we believe they will have a price in the future Behavioural economics is probably the starting point, the not ending point in price theory

11. What needs to be explained in equities Why do equity prices have the values they have at any point of time? Value of price not to be confused with the underlying value of an asset, which is what the textbooks on price theory did Some assets do have determinable underlying values – Cost of production (labour theory of value) – Asking price – the wishful thinking price – Bidding price – Competitive markets prices tend to cost of production – Surplus (profits) tend to zero – GM, Ford, Toyota – Determinable value of equities should tend to zero

12. Conclusion Having established that existing Price Theory Text books are not easily of direct assistance in explaining the price of equities – And price of equities is something economics should explain – And having a clearer understanding of what is the price – And that in theory price of many equities should be zero – And human behaviour (or stupidity) is the main basis of the price of equities – The attempt to re-contexualise the price of equities can be undertaken

13. The End Thank you