The Law of One Price in Financial Markets
Summary Anomalies
The Law of One Price in Financial Markets
Owen A. Lamont and Richard H. Thaler
The Law of One Price is an economic way of rational perspective to explain the expectation of price uniformity of a particular commodity or say any economics goods across national boundaries. The law tries to explain what a market price condition of a given goods should be, all things being equal, across global boundaries. This law will hold where every variable that has a causality effect on price variation are held constant. That is where there is absence of transaction cost and no restriction or barrier to trades
Lamont and Thaler (2003) try to use real word scenario to explain the functionality and effectiveness of the law of one price. Under the assumption that the law could be realistic in completive market with no transaction and barrier to trade cost. The point of interest is to see whether this law could be violated. Using the aspirin market as an example, Lamont and Thaler are able to justify that it is very easy to violate the law in a consumer goods market. There are many factors that shape the consumer buying decision and some of these factors can actually lead to the violation of the law of one price. Example of such factors may include consumer foreknowledge about a product, influence of friends and family, perception about substitute goods or similar goods with brand variation.
Owing to the factors that influence consumers buying decision of a consumers goods, it is difficult for Arbitrageur to have any influence in consumer goods market thereby causing the violation of the law of one price . Lamont and Thaler says there exist no open way to sell short a consumer product and because of preconception about a consumer product by the consumer, it is very difficult to predict when consumer will see the error in their way. In most instances, consumers realize their mistakes during post purchase evaluation
The Law of One Price in Financial Markets
Owen A. Lamont and Richard H. Thaler
The Law of One Price is an economic way of rational perspective to explain the expectation of price uniformity of a particular commodity or say any economics goods across national boundaries. The law tries to explain what a market price condition of a given goods should be, all things being equal, across global boundaries. This law will hold where every variable that has a causality effect on price variation are held constant. That is where there is absence of transaction cost and no restriction or barrier to trades
Lamont and Thaler (2003) try to use real word scenario to explain the functionality and effectiveness of the law of one price. Under the assumption that the law could be realistic in completive market with no transaction and barrier to trade cost. The point of interest is to see whether this law could be violated. Using the aspirin market as an example, Lamont and Thaler are able to justify that it is very easy to violate the law in a consumer goods market. There are many factors that shape the consumer buying decision and some of these factors can actually lead to the violation of the law of one price. Example of such factors may include consumer foreknowledge about a product, influence of friends and family, perception about substitute goods or similar goods with brand variation.
Owing to the factors that influence consumers buying decision of a consumers goods, it is difficult for Arbitrageur to have any influence in consumer goods market thereby causing the violation of the law of one price . Lamont and Thaler says there exist no open way to sell short a consumer product and because of preconception about a consumer product by the consumer, it is very difficult to predict when consumer will see the error in their way. In most instances, consumers realize their mistakes during post purchase evaluation
Cited: Lamont, Owen A. and Richard H. Thaler. Journal of Economic Perspectives—Volume 17, Number 4—Fall 2003—Pages 191–202