Market Timing Hypothesis

The market timing hypothesis says that the first order determinant of the capital structure of a corporation, which implies the components of equity and debts as their obligations, represents the proportional mis-pricing of the above stated securities when the firm requires funds for investments.
The market timing hypothesis was first introduced by Wurgler and Baker in the year of 2004. In other words it can also be said that the firms usually do not care whether the financing is done with equity or debt. The firms and corporations select the most suitable form of financing at the time of investment.

The market timing hypothesis also describes the theory that whether the firms should invest with the debt instruments or with equity. The market timing hypothesis is also referred to as one of the many theories of corporate finance.

The concept of market timing hypothesis is believed to counter the trade off theory and pecking order theory.
Since the theory of market timing hypothesis does not explain the reason behind the asset mis-pricing or the reason behind as to why the firms are more capable to tell when there’s a mis-pricing than the financial market, the market timing hypothesis is classified as a segment of the behavioral finance literature. But on the contrary, the theory only assumes that the mis-pricing exists in the market. The theory also gives an account on the firm’s behavior with the assumption that the firms are able in detecting the mis-pricing more efficiently than the markets.

If we follow the empirical evidence, it is noted that the response to the market timing hypothesis theory is mixed. The market timing typically refers to the decision of the buying or selling of the financial assets such as stocks while trying to predict the price movements of the future market. The prediction is usually based the market outlook or on the economic conditions coming out from the fundamental or technical analysis of the market.

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Last Updated on : 27th June 2013

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