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Thursday, September 08, 2005

Investors are mad for risk-appetite indices. What do they actually tell us?

America’s stockmarket edged past news on Monday August 29th that Hurricane Katrina was set to become the world’s costliest storm ever for insurers, helping to push oil above $70 a barrel: share prices moved up within half an hour of the market’s opening, though they fell again the next day. It was certainly not the first time that investors had bought stocks when the news was bad, like a pitcher shaking off his catcher’s signals. Were investors cleverly re-assessing economic fundamentals (basically solid growth and still-good prospects for corporate earnings) and upping their rational valuation of shares? Or were they just irrepressible exuberants on a tear?

This question, it turns out, is at the centre of one of the big divides in financial theory. Those who believe in efficient markets think that prices reflect all known information about future returns. If an investor happens to feel irrationally feisty when he rolls out of bed in the morning, no matter: smart money will move in and arbitrage away the difference between the price he paid for the share and the price that correctly reflects the discounted value of expected cash flows.

posted by Brian Moran @ 2:10 PM   0 comments

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