Value = Investment Value + Consumption Value ≥ Price

The Investment Value [IV] is the present value of the expected future cash flow that follows the transaction. Say you buy stocks today for $10,000 and expect to sell them in a year for $11,000. If you discount future cash flow with 10%/year, the present IV will in this example equal the price. If you instead spend the money on a car you will sell for $8.800 in a year, the IV is only $8,000.

The Consumption Value [CV] is the monetary value of the emotions the transaction derives. From the theories I'm familiar with risk is assumed to be the CV, and also most often negative, at least for the market as a whole. In the example above a risk adverse person would therefore demand higher return to buy the stocks. A risk seeker would on the other hand get a positive CV so that IV + CV > Price. For the car the CV must at least be $2,000 then.

Substitutes
My point is that everything is substitutable, so there is no distinct difference between buying shares, cars, food, holidays, or whatever. All money is spent to maximize the difference between the value and the price:

Max ∑(Value - Price); where all the spending of the income is summarized.

This implies by the way that:

∑Value ≥ Income = ∑Price

The Stock Market
Firstly, risk is not the only thing that influences the CV. Factors such as the dream of riches, the entertainment of price movements, and the social benefits one may have from being a shareowner; all are valuable as well (some of these may go under a broad definition of risk though).

Secondly, the market rewards different groups at different times. During bubbles the dreamers get rewarded, and their increased wealth makes a larger impact on the market. Therefore such a market may sometimes be self reinforcing, as described in 'Stocks as Molecules and How Phases Change'. Being in a beautiful dream is pleasant while still asleep.

Back to risk again; if it so that the higher the risk, the higher the expected return - and (of course - as implied) that the market is uncertain - when the market goes up from time t to t+1, the risk seekers will be a larger proportion of the market. This will again reduce the attractiveness of risky stocks, and low risk (by then called boring) will be better purchases. I have not tested this yet, but it can be done by looking at S&P after positive and negative periods and the return of different kinds of stocks.

'More pain, more gain' is thus a much better saying than 'no risk, no return'.

Leave a Comment	Name	Email (optional)
Message
Verification Code