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Price Vs Value

Is price equal to the value? This is a very subtle yet important topic to think about. I am again summarizing from a book "Capital Ideas" for the benefit of the starters of the program. I recommend this book strongly. I am not quoting the book verbatim and will try to put my thoughts in it. Please feel free to comment in any style you wish.

Economist agree that "value" refers to something that lies beneath or behind the prices observed in the marketplace.


What is this true value? This is a very subjective question and based on observation and inference of individuals. For e.g in a baseball game we have three umpires. They are trying to decide between a ball and a strike.

1st umpire : I call them "as I see them"
2nd umpire: I call them "as they are"
3rd umpire : "They aint nothing till i call them"

1st umpire reacts on what he sees at that instant of time and again his decision depends on what he sees from his post. 2nd umpire is more obeservant and claims that he picks balls from strikes as they are. Both of these gentleman bind themselves to the fabric of the rules of the games and try to behave rationally all the time. 3rd umpire is unique in his way that he says that the decision is totally dependent on the powers vested in him as an umpire and he wish it to use it in his own ways..

Is value a subjective quantity ? Or it needs some objective standards to be able to get measured? More importantly does the value emerges from the actual transaction that takes place between buyers and sellers agree on a price ? Is this price the value??

In theory, the competition always drive prices to the pint where the value and price agrees.

For e.g if wheat is selling at $2.50/bushel and cost only $1.50 to produce, we can say that the consumers value wheat more the price and its relatively scarce quantity. This will tempt farmers to plunge into farming marginal land for wheat that will produce less wheat per acre and hence mark their share in this profitable profession by making the wheat a scarce quantity.
On the other hand if consumers shifts from wheat to corn and the PRICE of wheat falls to $1.00, many farmers will give up wheat production decreasing the supply further until only those farmers who can produce wheat less than $1.00 keep continuing farming.

In this example we have a clear sense of value of the commodity under investigation. But what about stock prices? Wheat here is "ontic" in nature as it really exists. On the other hand stocks are "ontological" in nature, which means that they cant be touched but they exists in a essential way. Stocks are nothing but an idea of financial concept in our head.

The reason that stock prices jumps so much and its risky investment is that "there is nothing clear cut about their value".

Is GM worth $50 because of accountants who did the math of
(sum of Asset-sum of Liabilities)/total no shares to arrive at $50?

or is it the $40 arrived at by a financial security analyst who discounted all the cash flows from the future?

or it is $60 because there is a rumor that GM will be acquired or some big guy wants to buy more shares in the company or any other positive inside news about the company that makes it a more wanted investment on the street?

Clearly this analogy pose a question that cannot be answered in terms of mathematical signatures. Keynes published an article in 1936 "The general theory of Employment, Interest and Money" and used a term "Prospective Yield" to refer to the INTRINSIC VALUE of the asset.
It depends on the human nature which desires quick results, and a peculiar zest of making money quickly and that the average man will discount the remote gains in future at a higher rate.

Samuelson who was the most distinguished disciple of Keynes refuted his idea of a market place behaving like a casino. He published articles and referred "prospective yield" as "Shadow prices". shadow prices were totally in theory; never seen, felt or observed anywhere. However he insists that intrinsic value must exist.
How can we bring these prices from shadows to light. Echoing Bachelier, he said that the best estimates of the shadow prices are set in a marketplace during a transaction between a buyer and seller. These prices may not be an accurate measure of the intrinsic value but they can be considered to be a reasonably good estimates.

This was a strong statement that pulled investors from the academic theories of the capital market. These investors strongly believed that a significant basis exists between value and price and can be identified by skillful managers.

Thus in market place there is a constant struggle between buyers and sellers to predict the future accurately. Hence they arrive at a different price expectation on the same stock or commodity. If they agree on the price a transaction can take place which can be considered an estimate of value of the asset transacted at that instant of time.

Finding the true value is still a formidable task.

Comments welcome.
Nalin Aeron
Interesting subject. I had a salesman friend who didn't seem so bright, but always used to say: "That guy new the price of everything and the value of nothing."