The liquidity theory of asset prices

Gordon Pepper, Michael Oliver0470027398, 9780470027394, 9780470032770

Professional investors are bombarded on a day to day basis with assertions about the role liquidity is playing and will play in determining prices in the financial markets. Few, if any, of the providers or recipients of such advice can truly claim to understand the well–springs of such liquidity and the transmission mechanisms through which it impacts asset prices.
This groundbreaking new book explores the belief that at the core of liquidity there is a force which exerts individuals to effect a financial transaction when they would not otherwise do so.  Understanding this force of compulsion is a key to understanding a financial market when it appears to be behaving irrationally. This book will enable new and seasoned investors to develop an understanding of the factors, so that costly mistakes can be avoided without the lesson of experience.

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Table of contents :
The Liquidity Theory of Asset Prices……Page 6
Contents……Page 10
Foreword……Page 16
Acknowledgements……Page 20
About the Authors……Page 22
List of Tables, Figures and Charts……Page 26
Appetiser……Page 30
Language and Jargon……Page 31
Modern Portfolio Theory……Page 32
Fundamental Analysis……Page 33
Technical Analysis……Page 34
What the Book is Going to Say……Page 35
Part I the Liquidity Theory……Page 38
1 Types of Trades in Securities……Page 40
1.3 ‘Efficient Prices’……Page 41
1.4 Expectations of Further Rises or Falls……Page 42
2.1.1 Transactions Demand for Money……Page 44
2.2.1 Printing-Press Money……Page 45
2.3 Monetary Imbalances……Page 46
2.4 Excess Money in the Economy……Page 47
2.5 Summary……Page 48
3.2 Intuition……Page 50
3.3 Decision-Taking Inertia……Page 51
3.5 Fundamental and Monetary Forces in the Same Direction……Page 52
4 Discounting Liquidity Transactions……Page 54
4.3 Short-Term Risk Versus Profits in the Longer Term……Page 55
Appendix: Speculation and Market Patterns……Page 56
5.1 Introduction……Page 66
5.2.2 Business Cycles and Fundamental Factors: the ‘indirect Effect’ on Asset Prices……Page 67
5.3 Strategy……Page 68
5.4 Timing……Page 69
5.5 Sequences……Page 70
5.6 Triggers……Page 71
6.1 The Peak of a Business Cycle……Page 72
6.2 Running Down Bank Deposits……Page 73
Appendix 6A: Some Bond Arithmetic……Page 75
Appendix 6B: Government Bond Markets……Page 76
Part II Financial Bubbles and Debt Deflation……Page 78
7.1 Detection of a Bubble……Page 80
7.2.3 Acutely Dangerous……Page 81
7.3 Crosschecks……Page 82
8 Debt Deflation……Page 84
8.1.1 Money Supply Policy……Page 85
8.1.2 Fiscal Policy……Page 86
Appendix: Ignorance of Irving Fisher’s Prescription……Page 87
Part III Elaboration……Page 88
9 Creation of Printing-Press Money……Page 90
9.1 The UK in More Detail……Page 92
9.2 Four Policies……Page 93
10.1.1 The Teaching in Textbooks……Page 94
10.2 Bank Capital……Page 95
10.3 The UK in More Detail……Page 96
10.5 Relationship Between the Counterparts……Page 97
11.1 Summary……Page 100
11.2 Expected Yield……Page 101
11.3 Risk……Page 103
11.3.2 Variation in Risk – Life Assurance Funds……Page 106
11.3.3 Investment Managers’ Personal Risk……Page 107
11.4 Exploiting Skewness……Page 108
12.1 Trends and Trading Ranges……Page 110
12.3 Information……Page 111
12.5 Approaching a Turning Point……Page 112
12.7 Further Reading……Page 113
13.1.2 Technical Reactions……Page 116
13.1.4 Bulls and Bears of the Core Market-Makers……Page 118
13.2 Intuition that is not a Reflection of Monetary Forces……Page 120
13.3 Forced Selling……Page 121
14.2.1 An Hydraulic Model……Page 122
14.2.2 Large Electronic Computer Models……Page 123
14.3 Disequilibrium……Page 124
14.5 Accounting Identities……Page 125
Appendix: Direct Estimates of Supply and Demand for Credit in the US……Page 126
Part IV Evidence and Practical Examples……Page 130
15 The UK Markets Prior to 1972……Page 132
15.2 UK Money Supply and the Equity Market, 1927–72……Page 133
16 The US Equity Market 1960–2002……Page 138
17.2 Prediction of the October 1987 Crash……Page 142
17.3 Prediction of the Top of the US Equity Market in April/May 2000……Page 143
17.4 Postscript……Page 145
18.2 Japan in the 1990s and Early 2000s……Page 148
Part V Monitoring Data……Page 150
19.2 Which Aggregate?……Page 152
19.4 An Expert Approach……Page 154
19.5 Timing of the Availability of Data……Page 156
19.6 Understanding the Current Behaviour of the Market……Page 157
Appendix 19A: Monetary Targets in the UK……Page 158
Appendix 19B: Distortions to Monetary Data in the UK……Page 159
Appendix 19C: Velocity of Circulation……Page 160
20.1 Printing-Press Money……Page 168
20.3 The Counterparts of Broad Money……Page 169
20.5 Management Information……Page 170
20.7 The Public Sector’s Borrowing in Foreign Currency and from Abroad……Page 171
21 The Different Sectors of the Economy……Page 174
Conclusions for Investors……Page 176
Glossary……Page 178
References……Page 186
Index……Page 188