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The Optimality of a Competitive Stock Market

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  • Robert C. Merton
  • Marti G. Subrahmanyam

Abstract

The findings of Jensen-Long and Stiglitz on the optimality of the stock market allocation have led to a controversy over whether the sources of the nonoptimality of value maximization are noncompetive assumptions about the capital market or are inherent externalities associated with uncertainty which do not disappear even in a competitive market. At least, for the mean-variance model with constant returns to scale technologies, we claim that the answer is the former, and that the sources of the nonoptimality are nonpricetaking behavior by firms, restrictions on the availability of technologies to firms, and restrictions on the number of firms that can enter. Using both tatonnement and nontatonnement processes, it is shown that if firms value maximize, then the Jensen-Long and Stiglitz equilibria are unstable with respect to the number of firms. If the restrictions on the availability of technologies and on the number of firms that can enter are relaxed, then the equilibrium will be a Pareto optimum in most cases, and in no case will the aggregate amount of investment be less than the Pareto optimal amount. If firms act as price takers (with or without the other restrictions), then the equilibrium is a Pareto optimum

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  • Robert C. Merton & Marti G. Subrahmanyam, 1974. "The Optimality of a Competitive Stock Market," Bell Journal of Economics, The RAND Corporation, vol. 5(1), pages 145-170, Spring.
    • Handle: RePEc:rje:bellje:v:5:y:1974:i:spring:p:145-170
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    Cited by:

    1. Nitzan Weiss, 1984. "Capital Markets, Output, and the Demand for Inputs under Uncertainty," Eastern Economic Journal, Eastern Economic Association, vol. 10(1), pages 51-69, Jan-Mar.
    2. Luis H. B. Braido & V. Filipe Martins†da†Rocha, 2018. "Output Contingent Securities And Efficient Investment By Firms," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(2), pages 989-1012, May.
    3. Rajnish Mehra, 2013. "Asset Pricing Implications of Macroeconomic Interventions An Application to Climate Policy," NBER Working Papers 19146, National Bureau of Economic Research, Inc.
    4. David M. Kreps, 1982. "Multiperiod Securities and the Efficient Allocation of Risk: A Comment on the Black-Scholes Option Pricing Model," NBER Chapters, in: The Economics of Information and Uncertainty, pages 203-232, National Bureau of Economic Research, Inc.

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