Many people
don’t fully grasp how the stock market works and what its economic function
actually is. Behind all the complicated
maths and (deliberate and unhelpful) mystique is a very simple economic
function. Entrepreneurs need capital to
operate their businesses and individuals need outlets for savings. Individuals can give entrepreneurs money in
return for a SHARE of the company’s future profits or a STOCK of the company’s
capital. An individual can, at any time,
sell this right to a share in the company’s future profits to another
individual – this market, which can be organised or informal, is known as the
share market or stock market. Below is a
great cartoon from the 1950s, unearthed by Graeme Acheson, which provides a
helpful (if dated) explanation of how the stock market works.
Daron Acemoglu, Simon Johnson, Amir Kermani, James Kwak and Todd Mitton have written a paper on whether firms connected to Timothy Geithner benefited from these connections. They do so by looking at how stocks of these firms reacted to the announcement that he was a nominee for Treasury Secretary in November 2008. They find that there were large abnormal returns for connected firms. Below is the paper's abstract and the full paper is available here . The announcement of Timothy Geithner as nominee for Treasury Secretary in November 2008 produced a cumulative abnormal return for financial firms with which he had a connection. This return was about 6% after the first full day of trading and about 12% after ten trading days. There were subsequently abnormal negative returns for connected firms when news broke that Geithner's confirmation might be derailed by tax issues. Excess returns for connected firms may reflect the perceived impact of relying on the advice of a small ne...