YARDSICK

INTERNATIONAL
COLLEGE
ARTICLE REVIEW ASSIGNMENT

BY: DANIEL GETO ID WMBA/0460/12

Title: The Real Effects of Financial Markets

Author: Philip Bond, Alex Edmans and Itay Goldstein

 Introduction

The financial system of the economy never have been as stable that it’s not facing any hassles
need to be solved. The system has been facing several up and downs and crisis yesterday and no
one knows if it’s happening tomorrow or not. The secondary market is where investors buy and
sell securities they already own. It is what most people naturally think of as the stock market,
though stocks are also sold on the primary market when they are first issued the secondary
market permits participants who hold securities to adapt their holdings according to the
alterations in their evaluation of risks and returns. Once the new securities are issued in the
primary market, they are traded in the stock market up and onwards from the listing day. The
listing of stock enables liquidity and earning of status. The secondary market allows participants
who clasp securities to adapt their holdings according to the changes in their evaluation of risks
and returns. Once the new securities are issued in the primary market, they are traded in the stock
market up and onwards from the listing day. The listing of stock allows liquidity and earning of
reputation. There are different participants of the stock market in the financial system like
investors (banks, insurance, mutual funds, FII, etc) Issuers, including governments, corporate,
financial institutions, etcetera, and Regulators including the Central Banks.

Secondary markets are significant aspect of the economy. Through a huge chain of self-
governing yet unified trades, the secondary market steers the price of an asset toward its actual
value through the natural workings of supply and demand. It is also an indicator of a nation's
economic health. The increase or decrease in prices signals a growing economy or an economy
heading towards a recession.

Furthermore, secondary market makes additional economic value by lets more useful
transactions to occur and build a fair value of value. Secondary markets also give liquidity to the
economy as sellers can sell speedily and without difficulty due to a huge number of buyers in the
market.

 Summary and analysis of the article

The article underlines that Price efficiency is the concept that the price at which an asset sells
should already reflect all public supply and demand information pertaining to it. A variation on
the concept states that changes in this information are reflected instantly in the market price,
while yet another version states that the price already reflects information that is both publicly
and privately available. The concept implies that it should not be possible for an investor to
consistently earn excess returns.
By analyzing the paper of different scholars, the article narrates the concepts of price efficiency
and real efficiency and the link between them, the relation and distinction between forecasting
price efficiency and revolutionary price efficiency is elaborated by the authors of the article.

In discussing different ways in which revolutionary price efficiency fails they put three
arguments, elaborate and exemplify them. The price information system plays an important role
in every market in the decision-making process. An important task of management is to ensure
the control over operations, processes, activity sectors, and not ultimately on price. Although in
reaching the goals of market complete many control systems the price information system is
important because it monitors the results of the others. The detailed analysis of price, the
calculation of production price, the loss quantification, the estimating of work efficiency
provides a solid basis for the financial control.

Realistically, buyers and sellers may agree to prices that are different from what perfect
information about an asset would state that the price should be which suggests that price
efficiency is an imperfect concept. Besides, the benefit of efficient price and the value that it will
add to financial economists to make them make real decisions is also discussed briefly in the
article.

The other notion raised in the article is about the effect of incentives in decision making in the
investment. Top most ideas were the benefit of incentives in maximizing share price, by
increasing the price of the product, such as the price charged by competitors, the perceived value
received by your customers, and so on. But in the case of increased prices, even by just a few
percentage points Particularly in a low-margin business, even a modest increase in price might
have a significant impact, the importance of making comparison of managerial cost and benefit
of the investment, how pricing affects managers incentives and how incentive play a role in
bringing out desirable things to the manager.

In showing the implications of financial market and corporate finance Incentives in the form of
finance are expected to increase employee motivation because the incentives in the form of
financial employees can be allocated to the needs he wants. Giving this incentive requires a fair
and decent employee perspective. Fair has the meaning of financial incentives given the
company in accordance with or commensurate with the work and achievements achieved by
employees. While feasible means financial incentives given to employees can meet the needs of
these employees, the feasibility can also be seen by comparing the provision of incentives made
by other companies

Several factors are related to the problems that have been stated before, and the article covers the
secondary market area, this is because it plays important and irreplaceable role the emerging
economic system. Short selling is not a strategy used by many investors largely because the
expectation is that stocks will rise in value. The stock market, in the long run, tends to go up
although it certainly has its periods where stocks go down. Particularly for investors who are
looking at the long horizon, buying stocks is less risky than short-selling the market. Short
selling does make sense, however, if an investor is sure that a stock is likely to drop in the short
term. Short sellers are betting that the stock they sell will drop in price. If the stock does drop
after selling, the short seller buys it back at a lower price and returns it to the lender. The
difference between the sell price and the buy price is the profit. Short selling is riskier than going
long on a stock because, theoretically, there is no limit to the amount you could lose

The issue that whether irrational traders survive or not is the other point, the mechanism they
trace the price, and the hypothetical procedure of staying in the market or leaving the market. On
the other hand the procedure followed by rationale traders in the market and their benefit in the
economy which brought in to the market by their existence is also covered. Accordingly, correct
decision of the market and correct reflection of the firm by the traders is few of the ideas raised
in the scenario.

Finally, investors, are producers in the private economy. The private economy, in turn, supports
government — its programs, public sector employees, dependents, and so on. From a functional
point of view, the government is a burden that must be carried by the private sector. This is
neither a negative nor positive point; its just a reality.

The private sector has been able to shoulder the government and its related programs for
decades, and it has generally worked well. However, the growth has crossed a troublesome line
when you invest in stocks, you invest in companies. These companies, along with their
customers and investors, are producers in the private economy. The private economy, in turn,
supports government — its programs, public sector employees, dependents, and so on. From a
functional point of view, the government is a burden that must be carried by the private sector.
This is neither a negative nor positive point; it’s just a reality. The private sector has been able to
shoulder the government and its related programs for decades and it ha s generally worked well.
However, the growth has crossed a troublesome line by making tough analysis of several papers
in the article, the real effects of the secondary markets, its challenges, and the cross sectional
analysis

 Strong sides

Brief and deep analysis of papers of different scholars

Good coverage on benefits and features of the stock market

Different related issues of the secondary market is well covered

 Weak sides

Some ideas fragmented and are not well covered

The authors display their arguments on different ideas but it looks a bit unbalanced and away
from the basis of the matter of fact

 Conclusion

Deep and thorough analysis of the stock market is made theoretically and empirically.
Furthermore, the preliminary and higher level ides of the corporate faineance, market structure,
A stock exchange provides a platform to investors to enter into a trading transaction of bonds,
shares, debentures and such other financial instruments.

Transactions can be entered into at any time, and the market allows for active trading so that
there can be immediate purchase or selling with little variation in price among different
transactions. Also, there is continuity in trading, which increases the liquidity of assets that are
traded in this market.

Investors find a proper platform, such as an organized exchange to liquidate the holdings. The
securities that they hold can be sold in various stock exchanges. A secondary market acts as a
medium of determining the pricing of assets in a transaction consistent with the demand and
supply. The information about transactions price is within the public domain that enables
investors to decide accordingly. It is indicative of a nation’s economy as well, and also serves as
a link between savings and investment. As in, savings are mobilized via investments by way of
securities traditional and nontraditional pricing and the direction for future research in to
incorporate the feedback effect reviewed in this article into traditional asset pricing models to
explained

 Reference

Admati AR. 1985. A noisy rational expectations equilibrium for multi-asset securities markets.

Econometrica 53(3):629–57

Admati AR, Pfleiderer P. 2009. The “Wall Street Walk” and shareholder activism: exit as a form
of

voice. Rev. Financ. Stud. 22(7):2445–85

Aghion P, Stein J. 2008. Growth versus margins: destabilizing consequences of giving the stock

market what it wants. J. Finance 63(3):1025–58

Allen F. 1993. Stock markets and resource allocation. In Capital Markets and Financial
Intermediation,

ed. C Mayer, X Vives, pp. 81–115. Cambridge, UK: Cambridge Univ. Press
Asker J, Farre-Mensa J, Ljungqvist A. 2011. Comparing the investment behavior of public and
private

firms. Work. Pap., N.Y. Univ.

Baker M, Stein JC, Wurgler J. 2003. When does the market matter? Stock prices and the
investment

of equity-dependent firms. Q. J. Econ. 118(3):969–1006

Baker M, Wurgler J. 2012. Behavioral corporate finance: an updated survey. In Handbook of the

Economics of Finance, Vol. 2, ed. G Constantinides, M Harris, R Stulz. Amsterdam: Elsevier

Bakke TE, Whited TM. 2010. Which firms follow the market? An analysis of corporate
investment

decisions. Rev. Financ. Stud. 23(5):1941–80

Barro R. 1990. The stock market and investment. Rev. Financ. Stud. 3(1):115–31

Baumol WJ. 1965. The Stock Market and Economic Efficiency. New York: Fordham Univ.
Press

Benveniste L, Spindt P. 1989. How investment bankers determine the offer price and allocation
of

new issues. J. Financ. Econ. 24(3):343–61

Benveniste L, Wilhelm WJ. 1990. A comparative analysis of IPO proceeds under alternative
regulatory

regimes. J. Financ. Econ. 28(1–2):173–207

Bernanke BS, Gertler M. 1989. Agency costs, net worth, and business fluctuations. Am. Econ.
Rev.

79(1):14–31

Bernanke B, Woodford M. 1997. Inflation forecasts and monetary policy. J. Money Credit Bank.

29(4):653–84

Bernhardt D, Hollifield B, Hughson E. 1995. Investment and insider trading. Rev. Financ. Stud.

8(2):501–43

Bharath ST, Jayaraman S, Nagar V. 2012. Exit as governance: an empirical analysis.

J. Finance. Forthcoming

Biais B, Bossaerts P, Rochet JC. 2002. An optimal IPO mechanism. Rev. Econ. Stud. 69(1):117–
46

Bond P, Eraslan H. 2010. Information-based trade. J. Econ. Theory 145(5):1675–703

Bond P, Goldstein I. 2011. Government intervention and information aggregation by prices.

Work.

Pap., Univ. Penn.

Bond P, Goldstein I, Prescott ES. 2010. Market-based corrective actions. Rev. Financ. Stud.
23(2):781–820

Boot AWA, Thakor AV. 1997. Financial system architecture. Rev. Financ. Stud. 10(3):693–733

Brandenburger A, Polak B. 1996. When managers cover their posteriors: making the decisions
the

market wants to see. Rand J. Econ. 27(3):523–41

Bresnahan T, Milgrom P, Paul J. 1992. The real output of the stock exchange. In Output
Measurement

in the Service Sectors, ed. Z Griliches, pp. 195–216. Chicago: Univ. Chic. Press

Burton S, Seale G. 2005. A survey of current and potential uses of market data by the FDIC.
FDIC

Bank. Rev. 17(1):1–18

Chang C, Yu X. 2010. Informational efficiency and liquidity premium as the determinants of

capital

structure. J. Financ. Quant. Anal. 45(2):401–40

www.annualreviews.org _ The Real Effects of Financial Markets 357

Annu. Rev. Financ. Econ. 2012.4:339-360. Downloaded from www.annualreviews.org

Access provided by 196.189.121.6 on 01/26/21. For personal use only.

Chen Q, Goldstein I, Jiang W. 2007. Price informativeness and investment sensitivity to stock
price.

Rev. Financ. Stud. 20(3):619–50

Davis D, Korenok O, Prescott ES. 2011. An experimental analysis of contingent capital
triggering

mechanisms. Work. Pap., Fed. Reserve Bank Richmond

Derrien F, Kecskes A. 2012. The real effects of financial shocks: evidence from exogenous
changes

in analyst coverage. J. Finance. Forthcoming

Dow J, Goldstein I, Guembel A. 2011. Incentives for information production in markets where
prices

affect real investment. Work. Pap., Univ. Penn.

Dow J, Gorton G. 1997. Stock market efficiency and economic efficiency: Is there a connection?

J. Finance 52(3):1087–129

Dow J, Rahi R. 2003. Informed trading, investment, and economic welfare. J. Bus. 76(3):439–54

Durnev A, Morck R, Yeung B. 2004. Value-enhancing capital budgeting and firm-specific return

variation. J. Finance 59(1):65–105

Edmans A. 2009. Blockholder trading, market efficiency, and managerial myopia. J. Finance
64(6):

2481–513

Edmans A, Fang VW, Zur E. 2012. The effect of liquidity on governance. Work. Pap., Univ.
Penn.

Edmans A, Goldstein I, Jiang W. 2012a. Feedback effects and the limits to arbitrage. Work. Pap.,

Univ. Penn.

Edmans A, Goldstein I, Jiang W. 2012b. The real effects of financial markets: the impact of
prices

on takeovers. J. Finance 67(3):933–71

Edmans A, Manso G. 2011. Governance through trading and intervention: a theory of multiple

blockholders. Rev. Financ. Stud. 24(7):2395–428

Fama EF, Miller M. 1972. The Theory of Finance. New York: Holt, Rinehart & Winston
Fang VW, Noe T, Tice S. 2009. Stock market liquidity and firm value. J. Financ. Econ.
94(1):150–69

Faure-Grimaud A. 2002. Using stock price information to regulate firms. Rev. Econ. Stud.
69(1):169–90

Faure-Grimaud A, Gromb D. 2004. Public trading and private incentives. Rev. Financ. Stud.
17(4):

985–1014

Feldman R, Schmidt J. 2003. Supervisory use of market data in the Federal Reserve System.
Work.

Pap., Fed. Reserve Bank Minneap.

Ferreira D, Ferreira M, Raposo C. 2011. Board structure and price informativeness. J. Financ.
Econ.

99(3):523–45

Fishman MJ, Hagerty KM. 1989. Disclosure decisions by firms and the competition for price
efficiency.

J. Finance 44(3):633–46

Fishman MJ, Hagerty KM. 1992. Insider trading and the efficiency of stock prices. Rand J. Econ.

23(1):106–22

FlanneryMJ. 2009. Stabilizing large financial institutions with contingent capital

certificates.Work. Pap.,

Univ. Fla.

Foucault T, Fresard L. 2011. Cross-listing, investment sensitivity to stock price and the learning

hypothesis. Work. Pap., HEC Paris

Foucault T, Gehrig T. 2008. Stock price informativeness, cross-listings, and investment

decisions.

J. Financ. Econ. 88(1):146–68

Fulghieri P, Lukin D. 2001. Information production, dilution costs, and optimal security design.

J. Financ. Econ. 61(1):3–42

Gao P, Liang PJ. 2011. Informational feedback effect, adverse selection, and the optimal
disclosure

policy. Res. Pap. 11–13, Booth Sch. Bus., Univ. Chic.

Gilchrist S, Himmelberg CP, Huberman G. 2005. Do stock price bubbles influence corporate
investment?

J. Monet. Econ. 52(4):805–25

Glosten L, Milgrom P. 1985. Bid, ask, and transaction prices in a specialist market with
heterogeneously

informed traders. J. Financ. Econ. 14(1):71–100

Goldman E, Strobl G. 2012. Large shareholder trading and the complexity of corporate
investments.

J. Financ. Intermed. Forthcoming

358 Bond _ Edmans _ Goldstein

Annu. Rev. Financ. Econ. 2012.4:339-360. Downloaded from www.annualreviews.org

Access provided by 196.189.121.6 on 01/26/21. For personal use only.

Goldstein I, Guembel A. 2008. Manipulation and the allocational role of prices. Rev. Econ. Stud.

75(1):133–64

Goldstein I, Ozdenoren E, Yuan K. 2011a. Learning and complementarities in speculative

attacks.

Rev. Econ. Stud. 78(1):263–92

Goldstein I, Ozdenoren E, Yuan K. 2011b. Trading frenzies and their impact on real investment.

Work. Pap., Univ. Penn.

Grossman SJ. 1976. On the efficiency of competitive stock markets where traders have diverse

information. J. Finance 31(2):573–84

Grossman SJ, Stiglitz JE. 1980. On the impossibility of informationally efficient markets. Am.
Econ.

Rev. 70(3):393–408
Grullon G, Michenaud S, Weston J. 2012. The real effects of stock market prices. Work. Pap.,

Rice Univ.

Hart O, Zingales L. 2011. A new capital regulation for large financial institutions. Am. Law
Econ.

Rev. 13(2):453–90

Hayek F. 1945. The use of knowledge in society. Am. Econ. Rev. 35(4):519–30

Hellwig M. 1980. On the aggregation of information in competitive markets. J. Econ. Theory

22(3):

477–98

Hennessy C. 2009. Security design, liquidity, and the informational role of prices. Work. Pap.,
Lond.

Bus. Sch.

Hirshleifer D, Subrahmanyam A, Titman S. 2006. Feedback and the success of irrational

investors.

J. Financ. Econ. 81(2):311–38

Hirshleifer J. 1971. The private and social value of information and the reward to inventive
activity.

Am. Econ. Rev. 61(4):561–74

Holmstrom B, Tirole J. 1993. Market liquidity and performance monitoring. J. Polit. Econ.
101(4):

678–709

Jarrow R. 1992. Market manipulation, bubbles, corners, and short squeezes. J. Financ. Quant.
Anal.

27(3):311–36

Jayaraman S, Milbourn T. 2011. The role of stock liquidity in executive compensation. Account.
Rev.

87(2):537–63

Jegadeesh N, Weinstein M, Welch I. 1993. An empirical investigation of IPO returns and

subsequent
equity offerings. J. Financ. Econ. 34(2):153–75

Jennings R, Mazzeo M. 1991. Stock price movements around acquisition announcements and
management’s

response. J. Bus. 64(2):139–63

Kahn C, Winton A. 1998. Ownership structure, speculation, and shareholder intervention. J.

Finance

53(1):99–129

Kang Q, Liu Q. 2008. Stock trading, information production, and executive incentives. J. Corp.

Finance 14(4):484–98

Kanodia C. 1980. Effects of shareholder information on corporate decisions and capital market

equilibrium. Econometrica 48(4):923–53

Kanodia C, Lee D. 1998. Investment and disclosure: the disciplinary role of periodic
performance.

J. Account. Res. 36(1):33–55

Kau JB, Linck JS, Rubin PH. 2008. Do managers listen to the market? J. Corp. Finance
14(4):347–62

Khanna N, Mathews R. 2012. Doing battle with short sellers: the role of blockholders in bear
raids.

J. Financ. Econ. 106:229–46

Khanna N, Slezak SL, Bradley M. 1994. Insider trading, outside search, and resource allocation:
why

firms and society may disagree on insider trading restrictions. Rev. Financ. Stud. 7(3):575–608

Khanna N, Sonti R. 2004. Value creating stock manipulation: feedback effect of stock prices on

firm value. J. Financ. Mark. 7(3):237–70

Kim YH, Kang MJ. 2011. Stock market liquidity and short-termism-driven CEO turnover. Work.
Pap.,

Nanyang Technol. Univ.

Kiyotaki N, Moore J. 1997. Credit cycles. J. Polit. Econ. 105(2):211–48

www.annualreviews.org _ The Real Effects of Financial Markets 359

Annu. Rev. Financ. Econ. 2012.4:339-360. Downloaded from www.annualreviews.org

Access provided by 196.189.121.6 on 01/26/21. For personal use only.

Kogan L, Papanikolaou D. 2012. Economic activity of firms and asset prices. Work. Pap., Mass.

Inst. Technol.

Kyle AS. 1985. Continuous auctions and insider trading. Econometrica 53(6):1315–36

Kyle AS, Vila J. 1991. Noise trading and takeovers. Rand J. Econ. 22(3):54–71

Langberg N, Sivaramakrishnan K. 2010. Voluntary disclosures and analyst feedback. J. Account.

Res.

48(3):603–45

Lehar A, Seppi D, Strobl G. 2008. Using price information as an instrument of market discipline
in

regulating bank risk. Work. Pap., Carnegie Mellon Univ.

Leland HE. 1992. Insider trading: Should it be prohibited? J. Polit. Econ. 100(4):859–87

Luo Y. 2005. Do insiders learn from outsiders? Evidence from mergers and acquisitions. J.
Finance

60(4):1951–82

Maug E. 1998. Large shareholders as monitors: Is there a trade-off between liquidity and
control?

J. Finance 53(1):65–98

McCahery J, Sautner Z, Starks L. 2011. Behind the scenes: the corporate governance preferences
of

institutional investors. Work. Pap., Univ. Amst.

McDonald R. 2010. Contingent capital with a dual price trigger. Work. Pap., Northwest. Univ.

Michaely R, Shaw WH. 1994. The pricing of initial public offerings: tests of adverse selection
and

signaling theories. Rev. Financ. Stud. 7(2):279–319

Milgrom P, Stokey N. 1982. Information, trade, and common knowledge. J. Econ. Theory
26(1):17–27

Morck R, Shleifer A, Vishny RW. 1990. The stock market and investment: Is the market a
sideshow?

Brookings Pap. Econ. Act. 2:157–215

Mortal S, Reisel N. 2012. Capital allocation by public and private firms. J. Financ. Quant. Anal.

Forthcoming

Myers SC, Majluf NS. 1984. Corporate financing and investment decisions when firms have
information

that investors do not have. J. Financ. Econ. 13(2):187–221

Norli Ø, Ostergaard C, Schindele I. 2010. Liquidity and shareholder activism. Work. Pap., Nor.

Sch. Manag.

Ozdenoren E, Yuan K. 2008. Feedback effects and asset prices. J. Finance 63(4):1939–75

Paul JM. 1992. On the efficiency of stock-based compensation. Rev. Financ. Stud. 5(3):471–502

Rock KF. 1986. Why new issues are underpriced. J. Financ. Econ. 15(1–2):187–212

Roll R. 1984. Orange juice and weather. Am. Econ. Rev. 74(5):861–80

Singh R, Yerramilli V. 2010. Can transparency be too much of a good thing? Work. Pap., Univ.
Minn.

Stein JC. 1989. Efficient capital markets, inefficient firms. J. Finance 44(5):1335–50

Subrahmanyam A, Titman S. 1999. The going public decision and the development of financial

markets. J. Finance 54(3):1045–82

Sundaresan S, Wang Z. 2011. On the design of contingent capital with market trigger. Work.
Pap.,

Columbia Univ.

Wolfers J, Zitzewitz E. 2004. Prediction markets. J. Econ. Perspect. 18(2):107–26