November 2013

Markets And Economy

Understanding random market behaviour

 By Somali K Chakrabarti For an investor, the pain of selling a stock at a loss far exceeds the pleasure of selling the stock at an equal amount of gain. Strange but true! Such behavioral aspects of investing and many more are brought out in the study of behavioral finance, that was introduced in the late 1980s, owing to anomalies in stock price prediction by the two main existing theories of academic finance, i.e. Modern Portfolio Theory’ and ‘Efficient Market Hypothesis’. According to the ‘Efficient Market Theory’, put forth by Eugene Fama, financial markets are believed to be efficient and investors are understood to make rational decisions. Further, market participants are supposed to be sophisticated, informed and known to act only on available information. Since market participants are believed to have equal access to information, it is implied that stock prices always reflect the best information about fundamental values of the stocks. According to the efficient market theory and Capital Asset Pricing Model (CAPM) the price of a stock is the Present Value (PV) of all the entire future earnings of the company i.e. the future dividend paid by the company.  The ‘Modern Portfolio Theory’ pioneered by Harry Markowitz suggested that an…

Personal Effectiveness

Why you must build Professional Networks

. Networking is establishing and maintaining informal relationships with people whose acquaintance or friendship could bring advantages such as job or business opportunities. Professional networking is a critical skill that is required for succeeding at workplace or in business. Building a strong professional network doesn’t happen overnight; these relationships have to be cultivated over time.

Strategy

Diversification Dilemma

Diversification has given way to focus in developed countries like the United States and the United Kingdom,  and has often been correlated with lower performance. In contrast, diversified business groups have been hugely successful in most emerging markets, particularly in Asia. Since the mid 1980s, strategists in countries like the United States and the United Kingdom have mostly advocated the use of focused strategies for businesses and have advised companies to ‘stick to their knitting’. Many diversified conglomerates in these advanced economies have been dismantled since 1980s to focus on one or a few core businesses. A look at the motives with which companies diversify reveals some of the reasons why diversification by conglomerates yields benefits in the developing markets as against the discount associated with diversified conglomerates in the developed economies. Growth is a primary motive for diversification However growth does not always translate into higher profitability. Since management status and power is correlated more closely with the size of assets under management, management (the ‘agent’) may have the incentive to diversify for pursuing growth in preference to profitability, which is not in the best interest of shareholders. Reducing risk Having different businesses in their portfolio can potentially balance differences…

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