The Stock Market and Auctions: Considering Tesla Stock
http://money.cnn.com/2017/05/18/investing/tesla-elon-musk-valuation-market-cap/index.html
In a rudimentary viewpoint, the stock market is one example of a huge number of auctions occurring every instant, acting very much like a first price auction. A person can set a limit buy on a stock with his own “valuation,” and, provided that the auction goes through for that person, the person will receive the stock.
What is particularly interesting about the stock market is that the person’s own “valuation” of the product is much more dependent on what he perceives is the valuation of the product by others. As a result, the person will wait to buy a stock until it reaches a price that he believes is below the potential value of the stock – a strategy that is very similar to that of a first price auction.
And this strategy can result in anomalies in terms of valuation such as Tesla’s huge surge in valuation over the course of the summer. At the time, Tesla was losing a huge amount of money despite having grown to huge proportions, not being in its initial phases of development as a business or even a significant growth period – a huge red flag to any investor. But investors continued to buy into Tesla – seeing the significant upside in the future of a potentially outstanding technical company, despite seeing even the CEO speak of the company as overvalued. But their valuation is not set entirely on their own – although they develop some value for the company on their own, a portion of this valuation is based off of the perceived value by other people. People consider the prices and values considered by others when they are buying this stock. This thought process is quite similar to the strategy behind the buyer in a first price auction or an ascending price auction.
It is very interesting how the value of a single stock can increase almost arbitrarily in value simply by this ascending price auction – how a single person will increase their perceived value of a stock in a company just by observing others. This Price Discovery is an important part of the psychology behind economics.