A Market Equilibrium Model for the Management of Ordinary Share Portfolios

The paper describes the construction and application of a general price model based on the hypothesis that prices within an ordinary share market are in equilibrium after all participants have acted on their interpretation of the information available to them. The model can be regarded as a space time co-ordinate system in that all the attributes which affect the price of a share are described in terms of numerical scales and all the measurable changes over time in the equilibrium position correspond to changes in the position of a surface in 4-dimensional space. The application of the model to the U.K. ordinary share market is described. In particular, it is shown how the relative performance of a share can be resolved into various short-, medium- and long-term components, each of which can be studied in isolation using the model as a frame of reference. In the light of this practical experience, a detailed description of the price formation process within an ordinary share market is obtained. Since the principles underlying the practical application of the model have virtually nothing in common with the Modern Portfolio Theory methods currently in use in the United States, an attempt is made to reconcile the differing conceptual approaches. The empirical results of the market equilibrium model indicate that the theoretical foundations of Modern Portfolio Theory are somewhat insecure, and it is therefore concluded that the market equilibrium model offers the better scientific framework for the management of ordinary share portfolios.