Securities Values

Recent volatility in the stock market provides an excellent opportunity to reiterate the fundamental point about subjective value — i.e. the individual provides the source and measure of value.

If you have any temptation to see financial markets as an exception to the subjective theory of value, resist it. Value always arises from the individual. And, the individual’s ordinal scale of preference offers the only measure of value. That applies to financial instruments as well as any other economic good.

I have met several people who have studied the Austrian methodology in order to improve their investment performance. Most of them have given up the study because they have not realized an appreciable improvement in investment results. (Or, he could not see how to make a connection between investing in Austrian economic theory.)

This conclusion does not arise because of a flaw in the theory. Nor does it provide evidence that the subjective theory does not apply to financial markets. No. They get this impression because they do not fully internalize the concept of the subjective nature of the source and measure of value. As a result, they do not apply the theory in their investment practice.

So, briefly, how do people really value financial securities?

First, let’s eliminate the idea that a stock or a bond has any intrinsic value. We see evidence of that in daily fluctuations in securities prices. If the same security has the same “intrinsic” value from one day to the next, people would not exchange more (or less) money for the same securities from day to day.

Second, the small investor has a somewhat different reason to value a security than the large investor. He believes that someone in the future will pay more for that security than the cash he gives up today. If he anticipated that the future price, plus any dividends he receives, are sufficiently large to exceed his time preferences for cash today, he will buy that security. (The inverse applies to a sale.)

Third, the valuation process for the large investor (the one who owns a controlling interest) works the same. The only difference is a matter of scale. He buys (or sells) based on his anticipation that the future price for the entire enterprise will exceed his time preference for cash today.

In short, people value securities based on the subjective preferences in the same way that value any economic good. Some have called this — cruelly but accurately — “the bigger fool theory.”

Finally, evidence of subjective value exists with prices of entities that have not made money and don’t appear likely to making any in the future.

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