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Oct 05 2012

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What are the Features of a Perfect Capital Market

features of perfect capital market, capital market, stock market, primary market, secondary marketAn efficient capital market is perfect if the above mentioned conditions are fully satisfied. A capital market which is otherwise reasonably efficient will have imperfections to the extent it does not satisfy the conditions of the perfect capital market. There are three significant imperfections that may be found in most capital markets in different degrees. A perfect capital market imposes more stringent conditions. The following are the attributes of a perfect capital market:

  • Tax asymmetries: Most economies have varieties of taxes and tax incentives which cause tax asymmetries. These make security transactions more beneficial to some ones. A number of financial transactions may create additional wealth because of tax differences.
  • Information asymmetries: Most financial information are published and therefore, are publicly available. But sometimes, certain persons may have superior information than others. These persons may earn abnormal return for sometimes.
  • Transaction costs: These costs do not affect the prices. But, they can cause one transaction to be more profitable than the other. Transaction costs of two similar financial transactions may be different. Similarly transaction costs of two persons to a particular transaction may be different. In practice, capital markets have imperfections. Efficient markets may not be perfect. For developing frameworks for analyzing financial decisions, a good starting point is to assume that capital markets are perfect. Once a framework developed, the practical implications of market imperfections can be analyzed.
  • No entry barriers: Any one can participate in the market. Thus the suppliers or users of funds can enter the market and deal with each other.
  • Large number of buyers and sellers: Perfect competition in the market is ensured by the presence of large number of buyers and sellers of securities.
  • Divisibility of financial assets: Financial assets are divisible and therefore, affordable investments are made by all participants.
  • Absence of transaction cost: There are no transaction costs. Participants can buy and sell securities with ease and without many costs.
  • No tax differences: ideally, there are no taxes. There should not be any tax distortions. One set of investors should not be favored over others.
  • Free trading: Any one is free to trade in securities in the capital market. There should not be government restrictions on trading.

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