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Economics of Stock Market

ashish sharma , Last updated: 29 May 2013  


Economics of uncertainty can explain stock market forces and the structure and randomness of the markets. The theory underlying the financial markets is the same theory behind market transactions. Economics help us to understand oil prices, inflation, deflation, interest rates, monetary policy etc. It also help us to understand and analyze stock market practices like speculation, hedging and futures and options contracts. Financial markets play a major economic function by allowing people to take part in financial transactions and offer new channels of funding for corporates. Stock Market and the Economy: When markets are bullish stock prices go up, which is a general upward trend and a downside is observed when markets are bearish. This is quite often correlated with an increase in the value of the GDP only because both are driven by an increase in the supply of money and credit. But, to the contrary an increase in real GDP doesn't cause the stock market to go up. It is only due to the fact that during inflation the revenues of a firm increase before the costs rise in the income statement. This happens since the costs are expressed in the purchasing power of money in the past, as the costs that a company/firm incur are recorded in the income statement at a later point of time. Inflation and Interest Rates factor: An inflationary situation can result in a market boom when there is no increase in real wealth. If the money supply Is held constant, there will not be any significant rise in the value of stick market indicators in the long run, as the total value of the share price will remained stable. Again, interest rates can impact the fundamentals. High interest rates make current investment avenues less attractive and vice-versa.

Interest rates have a great influence on all investment options in general and specially on interest sensitive sectors like banking, housing, automobile etc. Low interest rates have a positive effect on the market, when all other factors are equal. The stock prices can ride under low interest rates only if the interest rates have fallen due to an increase in the rate of savings. The genuine savings in the economy do not increase during inflation. Stimulus packages: Government stimulus can raise the nominal monetary demand, but it has little positive effect on real demand as it doesn't reflect the real preferences of consumers. A very little money often reach the stock market as a result of public spending, if the newly created money by the RBI reaches the loan market, it can give a boost to the stock market in the short run.

The Random Walk Theory:

According to this theory the current stock prices reflects the future performance of the stock and the company to the extent it can forecast with the information currently available. It is based on the assumption that if stock prices do not fully reflect the future prospects, there lies an opportunity for investors to profit from the mismatch. Most economists subscribe to this theory. Discussion on stock market economics is incomplete without throwing some light on Rational Expectation Theory and Efficient Market Hypothesis, I think it necessary to make a detail discussion on these aspects which I would like to attempt in another article exclusively.

Thank you readers.

Ashish Sharma

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ashish sharma
Category Shares & Stock   Report



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