GOOD THEORY

Good Theory

Table of Contents

INTRODUCTION3

DISCUSSION4

CONCLUSION AND RECOMMENDATIONS15

REFERENCES19

BIBLIOFIGUREY20

Good Theory

Introduction

This paper attempts to prove that the test of a good theory is how well it stands up in the real world. The world is full of problems and some of the greatest problems are found in term of unpredictability. Knowing what will happen as a consequence from doing something now is therefore the essence of good theory because everybody want to be assured that what one has will turn out to be beneficial or will bear something good to that person. The world of business in particular is a worth of a big uncertainty where decision makers attempt to be correct in predicting the future. (Moffett 2006: 36-49)

To illustrate every investor wants to know if stock prices will go up or down in the near future since it could guide them in their wealth maximization objective. Knowing what will happen is the importance of having a theory to at least predict the real the real world. One theory that has been used to predict the future is the corporate structure theory which assumes that there a dividend policy is irrelevant as far as influencing stock prices is concerned. The rest of the paper therefore will discuss and analyze whether the capital structure theory is indeed a good theory on its capacity to stand up in the real world. (Mishkin 2005: 12-20) The test of a good theory is how well it stands up in the real world. Using empirical evidence, this paper critically examines the main theories of International Financial Management and assess the extent to which each stands up in the real world.

Discussion

Giving an example of Purchasing Power Parity (PPP or Law of One Price), which is an equilibrium condition that applies to the goods market. PPP does depend on the rapid adjustment of prices in response to arbitrage opportunities. If PPP would apply in the very short run then given a constant foreign price level fluctuations in the nominal exchange rate lead to equivalent variations in the price level. The real exchange rate is constant and the nominal side of the economy does not affect the real side (under continuous PPP, money does not affect output). The monetary model may be a good theory of long-run exchange rate determination (depending on the validity of PPP), but is very unlikely to be confirmed in the short run. This theory is about the concept of evolution of the currencies. It assumes that the price for a same good should be the same all over the world. If we assume that, comparing the prices of a same good or basket worldwide (that is to say in different currencies), is supposed to give us a clue on a currency's future fluctuation. (Jones 2004: 74-85)

But this theory has been elaborated assuming that the market was perfect, that there were no transportation costs and no official barriers to trade. In other words and to be valid, the prices of a same good/basket of good should be ...