Monday, 28 April 2014

Systemic drivers of overpricing in less than perfectly efficient markets

Anomalous historical asset price movements, showing disproportionately low or high volatility, can prove an asset effectively is not priced by a market, in which case the asset is likely to be overpriced.

The most basic sign of a manipulated asset price is too little movement. A share that barely moves is not plausibly priced by an efficient market. If extended, such a plateau is statistically unlikely to be caused by chance market dynamics, the result of interaction between a multitude of buyers and sellers with no interest or ability in moving the price. Such a plateau is more likely to be caused by an entity (or cartel of entities) with an interest in fixing the price at that level. There are numerous examples in the Australian share market of prices unnaturally fixed at plateaus. When share prices are openly fixed by criminals in this way, this is ignored by ASIC in every single instance.

The second most basic sign of a manipulated asset price is too much movement. If a share shows excessive volatility given the company's overall characteristics, it is unlikely to be caused randomly by an aggregately disinterested market. If a billion dollar company has daily share price gyrations of 10% on no news, it does not plausibly have a market-based price. Such price swings prove the existence of entities with the intent and power to move the share price. Myriad Australian companies now have volatility disproving their putatively market-based pricing, to various degrees. This is of course never investigated, even as policy funnels vast amounts of pension savings into the share market on the mere assumption of fair market prices.

If the price of an asset has been deliberately moved from market value, it is more likely to be overpriced than underpriced, simply because there is more money to be made from inflating asset prices. Based on inflated prices, capital is raised and fees paid. With rare exception fraud involves selling deliberately overpriced assets (rather than the opposite). Overpricing is more easily effected than underpricing. Anomalous price movements, proving an asset is not priced by a market, thus make it overwhelmingly likely the asset in question is overpriced. Since mispriced assets are likely to be overvalued, in aggregate the market is likely to be overvalued, to the extent that some assets are deliberately mispriced.

The rise of financial intermediaries is by far the strongest systemic driver of asset overpricing. In Australia, financial intermediaries form an oligopoly, exacerbating mispricing. When selling assets to the public, the intermediaries have a direct incentive for higher prices. When managing assets for the public, the intermediaries are incentivized to build unrealized profits, out of which cash fees are charged, regardless of whether these profits are eventually realized. There are more commissions, fees and bonuses if asset prices rise. These factors create a strong bias for asset overpricing, made possible by net investor inflows largely driven by mandatory superannuation and further leveraged by repressed interest rates.

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