A market is the means through which buyers and sellers are brought together to aid in the transfer of goods and/or services. Several aspects of this general definition seem worthy of emphasis.
First, a market need not have a physical location. It is only necessary that the buyers and sellers can communicate regarding the relevant aspects of the transaction.
Second, the market does not necessarily own the goods or services involved. For a good market, ownership is not involved; the important criterion is the smooth, cheap transfer of goods and services. In most financial markets, those who establish and administer the market do not own the assets but simply provide a physical location or an electronic system that allows potential buyers and sellers to interact. They help the market function by providing information and facilities to aid in the transfer of ownership.
Finally, a market can deal in any variety of goods and services. For any commodity or service with a diverse clientele, a market should evolve to aid in the transfer of that commodity or service. Both buyers and sellers will benefit from the existence of a smooth functioning market.
There are many financial markets, but they are not all equal—some are active and liquid; others are relatively illiquid and inefficient in their operations. To appreciate these discussions, you should be aware of the following characteristics that investors look for when evaluating the quality of a market.
One enters a market to buy or sell a good or service quickly at a price justified by the prevailing supply and demand. To determine the appropriate price, participants must have timely and accurate information on the volume and prices of past transactions and on all currently outstanding bids and offers. Therefore, one attribute of a good market is timely and accurate information.
Another prime requirement is liquidity, the ability to buy or sell an asset quickly and at a known price that is, a price not substantially different from the prices for prior transactions, assuming no new information is available.
An asset’s likelihood of being sold quickly, sometimes referred to as its marketability, is a necessary, but not a sufficient, condition for liquidity. The expected price should also be fairly certain, based on the recent history of transaction prices and current bid-ask quotes.
A component of liquidity is price continuity, which means that prices do not change much from one transaction to the next unless substantial new information becomes available. Suppose no new information is forthcoming and the last transaction was at a price of $20; if the next trade were at $20.05, the market would be considered reasonably continuous.2 A continuous market without large price changes between trades is a characteristic of a liquid market.
A market with price continuity requires depth, which means that numerous potential buyers and sellers must be willing to trade at prices above and below the current market price. These buyers and sellers enter the market in response to changes in supply and demand or both and thereby prevent drastic price changes. In summary, liquidity requires marketability and price continuity, which, in turn, requires depth.
Another factor contributing to a good market is the transaction cost. Lower costs (as a percent of the value of the trade) make for a more efficient market. An individual comparing the cost of a transaction between markets would choose a market that charges 2 percent of the value of the trade compared with one that charges 5 percent.
Most microeconomic textbooks define an efficient market as one in which the cost of the transaction is minimal. This attribute is referred to as internal efficiency.
Finally, a buyer or seller wants the prevailing market price to adequately reflect all the information available regarding supply and demand factors in the market. If such conditions change as a result of new information, the price should change accordingly. Therefore, participants want prices to adjust quickly to new information regarding supply or demand, which means that prices reflect all available information about the asset.
This attribute is referred to as external efficiency or informational efficiency.
In summary, a good market for goods and services has the following characteristics:
1. Timely and accurate information is available on the price and volume of past transactions and the prevailing bid and ask prices.
2. It is liquid, meaning an asset can be bought or sold quickly at a price close to the prices for previous transactions (has price continuity), assuming no new information has been received. In turn, price continuity requires depth.
3. Transactions entail low costs, including the cost of reaching the market, the actual brokerage costs, and the cost of transferring the asset.
4. Prices rapidly adjust to new information; thus, the prevailing price is fair because it reflects all available information regarding the asset.
No comments:
Post a Comment