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The Perfect Market Theory (No preferential treatment (In a perfect market…
The Perfect Market Theory
Homogenous commodity
The commodity dealt in must be such that any one unit is exactly the same as any other.
There is no opportunity for substitution
Although all ordinary quoted shares on a stock market the same for a company under the quotation rules, stock markets are divided into sectors. The companies within a sector are not all the same, enabling shares in one company to be substituted fro shares in another within the same sector
A large number of buyers and seller
For a sector that is in favour, there are normally a large number of buyers in the market. If a company is out of favour, there may be many sellers in the market.
Most of the time, stock markets will satisfy this requirement
Buyers and sellers are in close contact with one another
This requirement is satisfied within individual and global markets. The interest ensures that all buyers and sellers have ample opportunity to be aware of information likely to influence companies and markets on a worldwide basis
Some markets provide 24 hour dealing
No preferential treatment
In a perfect market there should be no preferential treatment of clients or discrimination by either buyers or sellers.
There must be no opportunity for insider dealing, which is illegal in all markets
It is impossible to stop the use of insider information completely, as in practice, markets rely on information to function and there is always an opportunity for information not available in the public domain to filter into a market
Market participants must be on their guard to avoid using information that could be considered insider information as abuse of this is heavily punishable in all countries, if tis were not the situation then confidence in markets would be lost
Transferability of a commodity
Entitlement or ownership of shares, bonds and other commodities are nowadays easily transferable but not only within a market but across the world
Costs may be involved especially due to currency exchange rates
Because markets are not perfect, there is an opportunity for arbitrage between markets worldwide to exist as a profitable business
It is questionable whether the five conditions are fulfilled. In spite of information being available more or less equally to all market participants, it is questionable whether the perfect market does exist in reality
People are different and therefore they interpret the same piece of information in many ways
PLCHT