Imperfections of capital markets

There is a great variation from country to country in the strength of securities markets, and especially of the long-term bond markets that are of particular interest to developing countries. Insurance companies, pension funds, trust funds and other institutional investors are the mainstay of bond markets; they not only provide the market with funds but also endow it with a high degree of professionalism and sophistication in the purchase and sale of securities. Where these institutions are weak or non-existent, as for example when social insurances reduce the need for private pensions and the public savings institutions channel their deposits to support government financial requirements, the bond market is correspondingly underdeveloped. The market then finds difficulty in 'digesting' large new issues and as a result new bond issues are frequently rationed. A second and quite different aspect of market imperfection is the often large divergence between the cost of issue to the borrower and the yield to the lender. The initial and recurrent costs vary considerable from country to country and tend to be larger for fund bonds. Other factors are the structure of interest rates as influenced by domestic economic policies, the interest rates themselves, and the ease with which new securities can be resold without loss, before maturity.

Partial deregulation of some of financial markets have resulted in inefficiency, distortions in prices and increased fraud. Abandoning fixed commission has forced all major financial houses to trade heavily on their own accounts in order to make up for lost commission revenue. They, are directly or indirectly, playing against their own customers. The major brokerage firms all have a good deal of power to manipulate intra-day market prices creating advantages for their customers and for themselves. Knowledge of major moves by customers provides a brokerage firm's traders with an edge in very short term speculation, and thus encourages more of it. Programme trading renders prices irrational. Stock index futures convey no real information beyond that already conveyed by current stock prices, the current price of the stock and their only function is to facilitate highly leveraged bets on broad market moves.