Efficient-market theory holds stocks are interchangeable rights to income streams

Evidence

At one level, the cause of an increase in price following a stock’s inclusion in the S&P 500 or similar indices seems straightforward: index funds, which as noted in chapter 3 have become an extremely large category of investor, do not hold the stock before its inclusion, and when it is included they have to buy it. Again, though, such an explanation is unsatisfactory from the viewpoint of efficient-market theory. It runs directly against a central tenet of finance theory, which goes back to Modigliani, Miller, Markowitz, and Sharpe but which was expressed perhaps most clearly by Myron Scholes on the first page of his Ph.D. thesis: “The shares a firm sells are not unique works of art, but abstract rights to an uncertain income stream for which close counterparts exist either directly or indirectly via combinations of assets of various kinds.” — Donald MacKenzie, An Engine, Not a Camera, 460

Categorization

• DEFINE: Quotes Scholes’ crisp statement of the efficient-market substitution principle — shares are ‘abstract rights’ with close counterparts, not unique works of art.
• XREF: connects to: An asset is property yielding an income stream, unlike a commodity for sale. — Kean Birch, Rethinking Value in the Bio-economy:…, 40; Index funds directly implemented financial economics’ efficient-markets claims — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 134; Market efficiency means prices fully reflect available information. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 291 (+3 more)

Broader Connections

• Efficient-market theory holds that stock demand curves are essentially flat #expands (0.85) — Donald MacKenzie, An Engine, Not a Camera, 1503