Price discovery
From Wikipedia, the free encyclopedia
The price discovery process is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers [1].
Price discovery is different from valuation. Price discovery process involves buyers and sellers arriving at a transaction price for a specific item at a given time. It involves [2]
- Buyers and seller (number, size, location, and valuation perceptions)
- Market mechanism (bidding and settlement process, liquidity);
- Available information (amount, timeliness, significance and reliability) including
- futures and other related markets
- Risk management choices.
In a dynamic market, the price discovery takes place continuously. The price will sometimes fall below the duration average and sometimes exceed the average as a result of the noise due to uncertainties.
The price would fluctuate between the support and resistance levels, which are associated with the ends of the expectation spectrum. Usually price discovery helps to find the exact price for a commodity or a share of a company. The price discovery is used in speculative markets which helps traders,manufacturers,exporters, farmers, oil well owners,refineries,governments,consumers and speculators.
The process involes transfer of the risk to another person who is ready to take the risk assuming that the demand for the given asset or commodity either goes up or goes down.
In a given market condition when farmers cannot demand a specific price the best option would be price discovery.
Price discovery process helps commodities which are consumed world wide and produced world wide. Governments do not involve majorly in fixing a perticular price to buy or sell therfore market forces help to discover appropriate price for an asset. Example- crude which is consumed world wide and also produced in different quatities in various nations, fixing the price becomes very difficult for one nation or for one individual. The mechanism of discovering the price helps oil importing nations as well as oil exoporting nation.
Lets look at farmers, they do have Maximum retail price printed on the farm produce. Hence the process of price discovery helps them to know what is the price for their produce.
Price discovery is not new. It has been for ages even during the barter trade days. The price discovery even in those days was based on demand and supply.
Factors that govern the price discovery:
Mass psychology- Usually we find that a group of people take decissions in a perticular pattern. The pattern is called as the golden ratio. The golden ratio was invented by a great Mathematican called Aryabhatta in India. This was then copied by Fibionacci and is now known as fibionacci series. The ratio is 62% and 38%. Mass psychology is one of the factors.
Production: Production levels contibute to the price discovery. It impacts the supply fundamentals. When required quantities are not produced price changes. In the same way in reverse direction too.
Weather conditions and seasons: Certain weather influences demand for commodities. For example wool during winter or heating energy requirements etc.
[edit] See also
- Auction
- Efficient market hypothesis
- Market-based valuation
- Pricing
- Real estate appraisal
- Stock valuation
- Arbitrage pricing theory (APT)
- Black-Scholes (for options)
- Single-index model
[edit] References
- ^ Equity Markets in Action: The Fundamentals of Liquidity, Market Structure & Trading, Robert A. Schwartz, Reto Francioni, John Wiley and Sons, 2004
- ^ http://agecon.okstate.edu/pricing/ Pricing and Price discovery Issues
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