Behavioral finance FAQ / Glossary (Price)

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Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
i: incidental

(bid, psychological) Price

08/4d

The trick is in the number.

To offer a price in decimals (i.e. 9.34 Euros),
or better, just under a round price (i.e. 19.99 Euros)

is actually a psychological trick.

This "psychological price"

Is usually perceived as more attractive and/or fair and honest,

Might limit haggling to a few ...decimals.

Seems also that, if you want a stock market order at 20 Euros to
get fulfilled,you better place it at 20.1 when buying and at 19.9
when selling.

(fair) Price

See (fair) value, fairness,
(bid, psychological) price.

Price anomaly


01/8i + see anomaly,
misalignment, value,
fair price, inefficiency

Are assets prices what they should be ?

To start with a platitude, what is called a "price anomaly", or a

  mispricing, occurs when some goods, service or asset

is underpriced or overpriced.

Underpriced, overpriced, what does thant mean ? As many platitudes,
this statement / definition is ambiguous.

But ambiguous formulations are often ...telltale and interesting.

The flaw of that near-tautology is in the idea of a possible "comparison"
with some "ideal" or "reasonable" price
.

The mispricing notion takes for granted that we can
compare
this item's current price with:

The average price of the same item seen in similar circumstances.

The current price of  other goods or assets that would

be considered rightly / efficiently priced at the moment,

A price norm that could be called the "fair price" (or "fair value",

or "efficient price").

Is price anomaly an objective notion?

Is it objective to have doubts about the price tag?


To talk about mispricing should not hide the fact that price is the tangible
and objective reality.

This is not the case of "value", a subjective or at least theoretical
notion
(see the articles on "value").

Therefore to compare price to value is relevant

  only to some extent.

All can be said is that there is in some cases a strong
suspicion of mispricing
as the price-making process
can be biased by irrational or technical factors.

Prices even become chaotic in periods of excessive volatility, the
meter's needle gets wild, prices become blurred and unreadable,
you cannot tell if the Schrödinger's cat is alive or dead.

Also there might be a wide range of different prices between sources,
contracts and markets.

Who can tell the price of an airline ticket, as yours can be quite different
from what the person seated near you has paid?

Dual anomalies in asset market:
    prices and return
s

Prices make returns and returns make prices
Strange prices
make strange returns and reciprocally.


In asset markets, price anomalies are linked to return anomalies
(see anomaly).

This is because a price rise  or fall  
is a key component of the return an asset a

buyer or seller  gets

Said more bluntly, in theory, an asset price is an anticipation of its returns.

The expected return and return risk are the main criteria used
in theoretical pricing / valuation models that are supposed to estimate the
right price and thus to detect a mispricing.

Origins of anomalies

How did it get wrong?

To dig deeper into the ambiguity of the concept, what is called a
mispricing,
a kind of market bug, might have quite different
origins:

Either practical / material defects (inefficiencies) in how the
  
market (*) works and in the way investors operate

(*) Or a public authority that decides prices in the lack  
     
of a free market.

Or behavioral biases that affect those deciders,

Or, last but not least, flaws in the valuation model  

chosen, either in the parameters it uses or in the data entered.

Here we have valuation anomalies, not price anomalies.

What to do about anomalies, in practice

Taking the crowded bus, or waiting for the next one?


Large price anomalies might be strongly suspected in some periods or

situations.

They can even reach extreme values in case of a bubble or a crash.

The question is: what will happen next?

Whatever the theory asserts, there is never a 100% certainty

that the market will correct "anomalous" prices
one day, and
sooner than later.

Of course there is neither a 100% certainty that it will
not correct them, maybe violently!
Be ready for everything!

By the way, in a non-market economy, it is even less certain that prices

will go back to "normal", but let us not talk politics here ;-).

When suspecting an asset mispricing, investors who play on the idea of a
fast correction might be disappointed
.

That correction, whatever good reasons there are to anticipate it, might take
a long time.

Investors better have a long time horizon.

And throw the sponge if things turn in the opposite way than
expected
.

 

Dates of related message(s) in the
Behavioral-Finance group
(*):

Year/month, d: developed / discussed,
i: incidental

Price information

00/9i,10i + see EMH,
information

Do markets know things we don't know
and reveal them via market prices?

Prices (if they are well known) are important information on any market
about the state and structure of supply and demand
.

The price levels give hints, among other traits, about

* the desirability expressed by the players,

* the cost and the availability of the goods, services and assets that are
   exchanged.

As for asset market prices some theoreticians say that
they include all the economic information needed.

If that assertion of the absolute pricing power of relevant information

was right, it would mean that prices contain:

The whole bundle of information , uneasy to untangle,

about the items traded and the market itself:

Hard facts related to the goods, services, and assets,

Soft facts also, such as the current crowd's mood.

As well as all the interpretations given to that mass

of information.









The (price   ~   information) loop

Price makes information,
information make price..
.

In asset markets, prices, and also price moves, are obviously information
that influence investment decisions
, and thus ...that influence the next
market prices.

Nothing guarantees that such a feedback loop gives a stable
equilibrium.

The wheel might stop, accelerate, revert its rotation...

How relevant is the information
    given by prices?

Infallible or fuzzy informers?


Some economic theories go further than considering prices as just information
among others.

Notably the EMH / efficient market hypothesis (see that acronym) holds
the bold idea that prices,and among them capital asset prices, contain all
needed information.

But prices are not totally trustworthy as information.

They give a fuzzy information as seen above.

Market are not always fully efficient. They have their share of inefficiencies
(over- / under- valuations)
caused by biased investor attitudes, beliefs, emotions /
motivations, behaviors.

Another thing is that prices are not always well known.

* They might be highly volatile (see volatility).

* Also there might be differences of prices between sources, buyers, contracts
   and markets.

Not only the price of your airline ticket, might largely differ from what
another person paid, but also some stock transactions are done in
"dark pools"
instead of the stock markets where they are listed.

Good bye, transparency!

The actual effects of price information

How will it be interpreted?


This influence of price levels and of price moves on decisions is not always
predictable in practice.

As an example, market players might perceive / interpret
a price rise as:

Either a deterrent to buy: there is a risk that the 
  
asset became overpriced,

Or an incentive to buy: if it rises, it is because it must be

   good .

Price moves and their consequences are sometimes irrational.

Beware of their influence, they are not fully reliable friends!

(Asset) Pricing

See CAPM, valuation,
mispricing, image

(*) To find those messages: reach that BF group and, once there,
      1) click "messages", 2) enter your query in "search archives".

Members of the Behavioral Finance Group,
please vote on the glossary quality at
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