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Comment by freehunter | Hacker News Reader

This is an important point. The stock market doesn't try to reward companies with higher share prices, it tries to find the correct price and stabilize there.

If your company is expected to do well, that performance is already built into your stock price. Doing exactly as well as expected, even if you've doubled your profits, won't cause your share prices to change at all. Because everyone already expected you to do that, so they were willing to pay more money to own your stock even before the official news.

The only thing that changes the stock market drastically is a surprise.

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What about uncertainty? Surely the removal of uncertainty would cause a movement in the price even when a company performs exactly as predicted?

No. Imagine a coin flip where you earn $1.1 on head and lose $1 on tail. What is the value of such a flip? $0.05

Now I offer you a coin flip with less uncertainty. It earns you $0.6 on head and loses you $0.5 on tail. Would you pay more then $0.05 for it? No. Uncertainty was reduced, but no value was created.

This assumes that people operate only on expected value and don't care about variance at all, which is incorrect empirically, theoretically, and intuitively. The premium you pay for reducing variance is called a "risk premium", and it follows pretty trivially from the diminishing marginal utility of money (though there are many other ways to derive/explain it). This is the entire reason that insurance exists as a product: it's not designed solely to cover existential risks or to prey on the irrational.

Well, if you pay me more then $0.05 for the $0.6/-$0.5 coin flip, I will happily sell you some. How much do you want?

I think GP disagreed with your assumption that a $1.1/-$1 coin flip was worth $0.05, so they'd pay more for the $0.6/-$0.5 coin flip than for the $1.1/-$1 flip, but still less than $0.05.

If that is true, then I will happily buy $1.1/-$1 flips for $0.049 from them!

They would pay a premium to avoid uncertainty, so they wouldn't accept that offer either. The uncertainty is the same whether you sell or buy the flips. I don't know you, but I guess you wouldn't pay $499K for a $1M/$0 flip, and you wouldn't sell such a flip for $499K either. This is the same phenomenon on a much smaller scale.

    I guess you wouldn't pay $499K for a $1M/$0 flip

No. But the discussion here is about shares. And they are not $499k a piece.

We are discussing if the share price of a company that publishes numbers in line with expectations should go up.

What do you mean by “expectations”? If Amazon trades a $2000, is the expectation that it will stay at $2000 forever? Or is the expectation that will go up because it will surpass expectations?

If by expectations we mean the numbers published by sell-side analysts they may or may not be close to the actual market expectations.

Say you can pay $10k and get (50/50) either $0 or $22k. The expected gain is $1k.

A second game also costs $10k to enter, but the (50/50) payouts are $9k and $13k.

Do you find then equally attractive? Most people wouldn’t.

If you do, what if you could instead “play” a game where you pay $10,000 and get $10,999 straight away? It’s a worse proposition if you’re risk-neutral, isn’t it?

And while it’s true that if markets were efficient you wouldn’t be compensated for diversifiable risk it’s also true that a) markets are not efficient and b) uncertainty in the results of companies is correlated with the market and not completely diversifiable.

Some funds are sufficiently large/diversified to avoid worrying about uncertainty in a single stock. If someone cared about this uncertainty, they would already have sold their shares to these funds before, so the reduction of uncertainty would have a negligible impact on share price.

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