The Ethics of Banking: Conclusions from the Financial Crisis (Issues ...

48 3 The Ethical Economy of the Capital Market
that the negative impact of the more pronounced price fluctuations caused by speculation
will cancel out the welfare effects deriving from the increased marketability
of shares.
Economic theory makes a distinction between speculation in shares with a negative
and a positive expected elasticity of demand for shares, as measured against
the stock exchange’s expectations. Speculation with a negative expected elasticity
describes speculative investment in shares which operates counter to the market’s
expectations, and thus buys shares when the market expects prices to be lower in
the future. This kind of speculation reduces stock price fluctuations by means of
a countercyclical investment strategy. Speculation with a positive expected elasticity
of demand for shares, in contrast, buys and sells shares in agreement with the
prevailing expectations of the market, trading cyclically along with the majority of
market participants. This kind of speculation further increases price fluctuations and
generates a negative welfare effect.
Stock market speculation is, however, most successful under two conditions:
firstly, if its anticipations regarding the future prices of shares are accurate, and
secondly, if it invests and disinvests countercyclically to the general market expectations
with negative expected elasticity of demand for shares. Speculation is not
very profitable if it follows the market expectations with positive elasticity and it is
absolutely unprofitable if its predictions of future prices are wrong. There is nevertheless
a tendency inherent to speculation, induced by the profit motive, to anticipate
future stock price changes correctly, and there is an incentive to speculate in such
a way that, because of the higher profit-rate of speculation under negative expected
elasticity, the higher profits likely to be yielded by countercyclical speculation tend
to lessen the fluctuations of the stock exchange.
The insight that speculation in the spot market for corporate shares decreases
uncertainty about the future transformability of holding periods justifies the conclusion
that the function of speculation in the market for corporate shares is to reduce
the uncertainty of market participants, and that this function cannot be performed
with other instruments. The risk attaching to a firm’s earnings or its insolvency can
be reckoned approximately by the market. However, no probability calculus can
help it to reckon the uncertainty concerning the duration of future holding periods,
i.e. the time-spans for which investors will want to hold their investments. 21 This
uncertainty is a matter for “speculation” alone.
The two components of speculation should therefore be differentiated.
Speculation can be divided into one part of pure speculation about the trajectory
of securities prices, a trend line that takes shape under conditions of chance and
uncertainty and is independent of earnings, and its counterpart which is genuine,
long-term investment in corporate shares and bears risk as an owner and partner.
Although these two components of speculation should be clearly differentiated
21 On the distinction between risk and uncertainty cf. FRANK KNIGHT: Risk, Uncertainty, and
Profit, New York (Houghton Mifflin) 1921.