CASE - 4 Indian Stock Market: Does it Explain Perfect Competition?
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CASE - 4 Indian Stock Market: Does it Explain Perfect Competition?


The stock market is one of

the most important sources for corporates to raise capital. A stock

exchange provides a market place, whether real or virtual, to facilitate the exchange of securities



between buyers and sellers. It provides a real time trading information on the listed securities,

facilitating price discovery.

Participants in the stock market range from small individual investors to large traders, who can be

based anywhere in the world. Their orders usually end up with a professional at a stock exchange, who

executes the order. Some exchanges are physical locations where transactions are carried out on a

trading floor. The other type of exchange is of a virtual kind, composed of a network of computers and

trades are made electronically via traders.

By design a stock exchange resembles perfect competition. Large number of rational profit

maximisers actively competing with each other, trying to predict future market value of individual

securities comprises the main feature of any stock market. Important current information is almost freely

available to all participants. Price of individual security is determined by market forces and reflects the

effect of events that have already occurred and are expected to occur. In the short run it is not easy for

a market player to either exit or enter; one cannot exit and enter for few days in those stocks which are

under no delivery. For example Tata Steel was in no delivery from 29/10/07 to 02/11/07. Similarly one

cannot enter or exit on those stocks which are in upper or lower circuit for few regular trading sessions.

Therefore a player has to depend wholly on market price for its profit maximizing output (in this case

stock of securities). In the long run players may exit the market if they are not able to earn profit, but at

the same time new investors are attracted by rise in market price.

As on 01/11/07 total market capital at Bombay Stock Exchange (BSE) is $1589.43 billion (source:

Business Standard, 1/11/2007); out of this individual investors account for only $100bn. In spite of the

fact that individual investors exist in a very large number, their capital base is less than 7% of total

market capital; rest of capital is owned by foreign institutional investor and domestic institutional

investors (FIIs and DIIs), which are very small in number. Average capital owned by a single large

player is huge in comparison to small investor. This situation seems to have prompted Dr Dash of BSE

to comment 'The stock market activity is increasingly becoming more centralised, concentrated and non

competitive, serving interest of big players only." Table 2 shows the impact of change in FII on National

Stock Exchange movement during three different time periods.



Table 2: Impact of FIIs' Investment on NSE


Wave Date Nifty

close


Change

in

N

if

t

y

I

n

d

e

x


FLLS

Net

Inv

est

me

nt

(Rs.Cr.)


Change

in

Mark

et

Capit

alisati

on

(Rs.Cr.)


Wave 1

From

To


17/05/04

26/10/05


1388.75

2408.50 1019.75 59520 5,40,391


Wave 2

From

To


27/10/05

11/05/06


2352.90

3701.05 1348.15 38258 6,20,248


Wave 3

From

To


12/05/06

13/06/06


3650.05

2663.30 -

986.7

5


-9709 -4,60,149



By design, an Indian Stock Market resembles perfect competition, not as a complete description (for

no markets may satisfy all requirements of the model) but as an approximation.


Questions

1. Is stock market a good example of perfect competition? Discuss.

2. Identify the characteristics of perfect competition in the stock market setting.

3. Can you find some basic aspect of perfect competition which is essentially absent in stock market?

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