Perfect Market, Arbitrage, and Value Creation in the MM Proposition

23 Pages Posted: 24 Apr 2020

Date Written: March 14, 2020

Abstract

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

Abad, Pharos, Perfect Market, Arbitrage, and Value Creation in the MM Proposition (March 14, 2020). Available at SSRN: https://ssrn.com/abstract=3554322 or http://dx.doi.org/10.2139/ssrn.3554322

Pharos Abad (Contact Author)

Ping-Tang University ( email )

China

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