The market timing hypothesis is a theory of how firms and

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s in the

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decide whether to finance their investment with

equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the diff ...

or with

debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...

instruments. It is one of many such

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theories, and is often contrasted with the pecking order theory and the

trade-off theory The trade-off theory of capital structure is the idea that a company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits. The classical version of the hypothesis goes back to Kraus and Litzenberger ...

, for example. The idea that firms pay attention to market conditions in an attempt to time the market is a very old hypothesis. Baker and Wurgler (2002), claim that market timing is the first order determinant of a corporation's

capital structure In corporate finance, capital structure refers to the mix of various forms of external funds, known as capital, used to finance a business. It consists of shareholders' equity, debt (borrowed funds), and preferred stock, and is detailed in th ...

use of debt and equity. In other words, firms do not generally care whether they finance with debt or equity, they just choose the form of financing which, at that point in time, seems to be more valued by

financial markets A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial ma ...

. Market timing is sometimes classified as part of the

behavioral finance Behavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the decisions of individuals or institutions, such as how those decisions vary from those implied by classical economic theory. ...

literature, because it does not explain why there would be any asset mispricing, or why firms would be better able to tell when there was mis-pricing than

. Rather it just assumes these mis-pricing exists, and describes the behavior of firms under the even stronger assumption that firms can detect this mis-pricing better than markets can. However, any theory with time varying costs and benefits is likely to generate time varying corporate issuing decisions. This is true whether decision makers are behavioral or rational. The

empirical evidence Empirical evidence for a proposition is evidence, i.e. what supports or counters this proposition, that is constituted by or accessible to sense experience or experimental procedure. Empirical evidence is of central importance to the sciences ...

for this

hypothesis A hypothesis (plural hypotheses) is a proposed explanation for a phenomenon. For a hypothesis to be a scientific hypothesis, the scientific method requires that one can test it. Scientists generally base scientific hypotheses on previous obse ...

is at best, mixed. Baker and Wurgler themselves show that an

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of financing that reflects how much of the financing was done during hot equity periods and how much during hot debt periods is a good indicator of firm leverage over long periods subsequently. Alti studied issuance events. He found that the effect of market timing disappears after only two years. Beyond such academic studies, a complete market timing theory ought to explain why at the same moment in time some firms issue debt while other firms issue equity. As yet nobody has tried to explain this basic problem within a market timing model. The typical version of the market timing hypothesis is thus somewhat incomplete as a matter of theory.

References

{{reflist Corporate finance Debt Finance theories

See also

References