Paradigm Shift in Finance: The Transformation of the Theory from Perfect to Imperfect Capital Markets Using the Example of Company Valuation

Ernst, D./Gleißner, W. (2022): Paradigm Shift in Finance: The Transformation of the Theory from Perfect to Imperfect Capital Markets Using the Example of Company Valuation, in: Journal of Risk and Financial Management, Vol. 15, No. 9, S. 399 ff

14 Pages Posted: 14 Apr 2023

See all articles by Dietmar Ernst

Dietmar Ernst

Nuertingen-Geislingen University

Werner Gleißner

Dresden University of Technology - Faculty of Economics and Business Management

Date Written: September 8, 2022

Abstract

In the capital market and financing theory, we are currently observing major upheavals. For decades, the neoclassical paradigm has dominated in science and practice. Triggered by economic and political crises, transformations, the COVID-19 pandemic, and political instabilities, a paradigm shift is currently occurring in finance. This paradigm shift leads to models and theories that can explain imperfections in capital markets and provide decision support for managers. The aim of this article is to analyse the paradigm shift and to demonstrate it using an example of business valuation theory. We draw on the insights of the philosopher Thomas Samuel Kuhn. He vividly explains the paradigm shift in science in his major work “The Structure of Scientific Revolutions”. A paradigm shift in science always encounters resistance. The reasons for this include the strong neoclassical school in finance and the dependence on research funds. Funders expect the use of established methods and the simplicity and dissemination of the models that have prevailed so far. On the other hand, the neoclassical models are unsuitable to explain the transformation processes on financial markets. This fact has been empirically proven. We show a variety of arguments that speak clearly about this paradigm shift. Their importance clearly outweighs the reasons to continue subscribing to the old paradigm. Accordingly, new theories and models have been developed to better explain the changes in the markets. With the simulation-based business valuation, an approach has been developed that considers different degrees of market imperfections. The simulation-based valuation can also depict the special case of the neoclassical paradigm, so that all market constellations can be covered.

Keywords: capital market theory, CAPM, company valuation, Monte Carlo simulation, paradigm shift, simulation-based valuation

Suggested Citation

Ernst, Dietmar and Gleißner, Werner, Paradigm Shift in Finance: The Transformation of the Theory from Perfect to Imperfect Capital Markets Using the Example of Company Valuation (September 8, 2022). Ernst, D./Gleißner, W. (2022): Paradigm Shift in Finance: The Transformation of the Theory from Perfect to Imperfect Capital Markets Using the Example of Company Valuation, in: Journal of Risk and Financial Management, Vol. 15, No. 9, S. 399 ff, Available at SSRN: https://ssrn.com/abstract=4405696

Dietmar Ernst

Nuertingen-Geislingen University ( email )

Parkstr 4
Geislingen, 73312
Germany

Werner Gleißner (Contact Author)

Dresden University of Technology - Faculty of Economics and Business Management ( email )

Mommsenstrasse 13
Dresden, D-01062
Germany

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