The dispersion of expectations in a speculative market

Steindl, Josef

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Document type:: Works

Collection:: Josef Steindl Collection

Title:: The dispersion of expectations in a speculative market

Author:: Steindl, Josef

Scope:: Typoskript mit einigen Tippfehlern, 3 Blätter

Year of publication:: 1990

Language:: English

Topic:: Firm and market structure

JEL Classification:: G17 [Financial Forecasting and Simulation]

Shelfmark:: S/M.77.2

DOI:: https://doi.org/10.48671/nls.js.AC14446338

THE DISPERSION OF EXPECTATIONS IN A SPECULATIVE MARKET. It may be assumed with some plausibility that the participants in a speculative market - for example a market for bonds or for foreign exchange - have different expectations with regard to the future price, or the direction in which prices are going to change. Contrary to some opinions this diversity of expectations is a condition for the attainment and maintenance of equilibrium in these markets; it must be fulfilled in order to assure that an additional offer coming from outside will find buyers or that an additional demand coming from outside will will find sellers. A further condition is that there must be a generally accepted idea of a normal price level to which prices ultimately tend to return. This normal price will be a range of prices rather than one single price. Though the estimate of this range of prices may not be uniform either, it is much more uniform than the earlier mentioned price expectations: It must have some basis in objective facts. Thus in the case of a manufactured good there may be some general information about the range of costs. In the case of an exchange rate there is - or at least there used to be - an idea about purchasing power parity or relative cost, although in our times this has obviously become more and more an obscure and irrelevant quantity. In the case of the long term rate of interest there used to be a historical experience that it rarely goes outside a certain range, but again this "basis in fact" has become more and more shaky in view of the violent fluctuations of modern capital markets. The undermining of concepts of normalcy in certain markets has been accompanied by great instability, so that it does not contradict but rather tends to confirm the rule that generally accepted ideas of a standard of normalcy are necessary in order to maintain more or less stable markets. The different expectations of participants in a market could be ordered in the form of a frequency distribution. It will be the distribution of participants in a market according to expected price. For the purpose of this representation we must assume that the expectations of different people are (approximately) independent of each other. The object of the expectation is the price after a certain time, or wbat is equivalent, the appreciation or depreciation within that time. There is thus a certain time horizon; we shall assume that it is given and is the same for all the participants. This is quite unrealistic but the purpose of the present note is to explain a certain approach and this would fail in its purpose if all the complications were taken into account. In the case of a market in long term bonds let us assume in the first instance that each of the participants has the same amount of financial resources which he can either invest in bonds or hold as cash ( or treasury bills ). We assume that the total of disposable financial funds (the "material" of the market, as it were) is given. We can draw a cumulative distribution function showing the number of people who expect a price equal to or lower than p, say F(p)(see figure 1). These people will hold money if the ruling price is p, while all the others,(1 - F(p)), will hold bonds. We shall first consider changes in the market which can occur while the total amount of funds remains unchanged. This may happen if the expectation of one of the bond holders changes and he shifts from the bulls to the bears, i.e. he wants to sell his lot of bonds. He must find somebody who is willing to buy them and for this purpose he must induce somebody to change from bear to bull. This is achieved if the market price declines by p so that somebody whose expectation was formerly below the market price finds that it is now above it. Another case occurs if one of the participants issues new bonds in order to repay some debts in cash. The market price of bonds will have to decline so that a number of participants will shift from bears to bulls, i.e. will be willing to hold bonds. The proportion of bonds will have

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