Subjectivism and Economic Analysis: Essays in memory of Ludwig ...

EXPECTATIONS AND STOCK MARKET PRICESdiversity of opinion about equity values. Two important featuresof his analysis are that it applies to a share with severely restrictedshort-selling opportunities and that the number of potentialholders of the share substantially outnumber the shares offered bythe company. Miller s central result is as follows: only in thespecial case of the absence of any diversity of opinion about thevalue of the share will its market price correspond to the averageevaluation. In all other cases the share will tend to be held by thatproportion of potential investors who hold particularly optimisticviews about its value. 10 He derives this result from elementarydemand and supply analysis. The vertical axis measures the‘estimates of value’ per share made by heterogeneous investors, thehorizontal axis the number of shares demanded and supplied ateach estimate of value. 11 The equilibrium price is given as usual bythe intersection of the demand and supply schedules. Withrestricted short selling, the supply curve is vertical at the number ofshares outstanding. Furthermore, in the absence of diversity ofopinion, the demand curve is horizontal. In this case, and in thiscase only, will the equilibrium price reflect the average of theinvestors’ evaluations. A diversity of opinion, in contrast, will bereflected in a downward sloping demand schedule, that is, thenumber of investors willing to hold the share will rise as the pricefalls. Here the price of the share will be higher than in the formercase, reflecting the views of the more optimistic segment of themarket rather than the average evaluation. The point is that theslope of the demand curve depends on the diversity of opinion. Thegreater the prevailing uncertainty, and hence the greater thediversity of opinion about the value of the share (and the steeperthe demand curve), the higher its price will be.What can be said about the impact of changes in the diversity ofopinion on the price of a share? First, we must stress that theconception of an ‘equilibrium’ share price implies nothing about itsstability. In the present setting the price of the share will alterwhenever its supply, the demand for it, or both, change. 12 A changein supply (a shift of the vertical supply curve) will occur as the resultof the company issuing new shares or buying back existing ones,and the effect on the price of such activity will be greater the greaterthe diversity of opinion in the market. 13 But this is probably the lessimportant case and we shall concentrate on the demand for theshare, taking its supply as given. We have already seen that the sharewill tend to be more ‘overpriced’ relative to the average evaluationthe higher the diversity of opinion in the market. The question then189