Types of ” Special Situations” and reasons for their existence

Special situations

1. New longer-term activities that are supported by a secular hypothesis but are yet to gain broad-based acceptance (e.g. Water, agriculture, carbon credits, etc.) => first-mover advantage

2. Short term activities that materialize due to sharp dislocations (especially of the “market-for-lemons” type) that involve significant overshoots (e.g. distressed securities, fallen angles, etc.)

“market-for-lemons” or MFL

– 2ndhand cars with hidden defects are called “lemons”

– mkt prices of the good cars are contaminated by the known presence of lemons among the cars on sale

– bottom-up signals too weak and easily overwhelmed by top-down concerns

– normal market signals unable to close quickly the information gap with the result that the market unravels – and such unraveling includes the withdrawal of higher-quality suppliers who react to the decline in the perceived average quality of the market

– how to identify MFL situations? By evaluating individual prices against the fundamentals and by seeing how these prices have moved relative to those in competing and complementary asset classes

– “buying cherries for the price of lemons”

Factors beyond traditional market imperfections

– weak governance system

– fluid property rights

– uneven application of the rule of law

 

Rational Fools

– predominantly rational market participants are occasionally impacted by distortive influences, and, as a result, valuation and liquidity dislocations emerge as markets adapt slowly to the new realities.

– if rational fools exist, need to consider

1) Will they give way to further distortions;

and

2) does the desirable reaction by rational and well-informed investors entail further deviations from equilibrium conditions?

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