Perfect Market, Arbitrage, and Value Creation in the MM Proposition
23 Pages Posted: 24 Apr 2020
Date Written: March 14, 2020
The real contributions of the MM Proposition are its central assumptions of perfect capital markets and the associated arbitrage argument. In this text, we review the perfect market assumptions and no-arbitrage principle. Then, to explain the evolution of the understanding of arbitrage from a deterministic world into an uncertain world, we restate and comment on the proofs of the MM Proposition in current perspectives. With the no-arbitrage principle in mind, we clearly read the circular justification in the MM Proposition and the misleading concept of cost of equity. From the perspective of the distribution of a corporation's value creation, we find that shareholders prefer a maximum degree of debt. However, we believe that the capital structures are mainly constrained by industry characteristics and the market timing of equity and debt financing.
Keywords: Perfect Market, No-Arbitrage Principle, MM Proposition, Capital Structure, Cost of Equity
JEL Classification: G12, G32, D24
Suggested Citation: Suggested Citation