Models of return generation for securities are potentially important for a number of reasons, including their possible utility in normative portfolio construction. Multi-index models of the process are frequently suggested as an alternative to the familiar single-index models, but, while the multi-index models are intuitively appealing, their empirical superiority remains largely undemonstrated. This paper examines the extent to which three multi-index models succeed in eliminating dependence in the return residuals for a portfolio of common stocks. The relevance of this research lies in the promise that, while obviously requiring additional inputs to determine the efficient set of portfolios, multi-index models may succeed in identifying a more accurate set of efficient portfolios.

Some recent works dealing with the subject of investment in common stocks have made cautious reference to the potential of some published, leading economic time series as inputs to stock price forecasting models. However, no prominent reports of systematic empirical research of the predictive usefulness of such series have appeared in the literature. Our study was designed to partially correct this seeming oversight.

This paper is concerned with costs of capital in mathematical programming formulations of the problem of capital budgeting under capital rationing. It shows that there is a serious error in the method outlined by previous authors for converting the shadow prices from the solution of the dual into measures of the firm's marginal internal opportunity rates. In addition to demonstrating that the traditional approach leads to erroneous and nonsensical results, this paper presents a correct procedure for determining these rates.

In the literature dealing with bond price volatility, there have been two divergent approaches. On the one hand, theoretical papers have looked at bond price volatility in the instantaneous framework of the calculus. Using the derivative of bond price (P) with respect to yield to maturity (y), it has been shown that volatility is linearly related to this derivative (dP/dy). (See [10].)

Most large companies develop formal or informal agreements with banks to cover anticipated seasonal or temporary cash needs and/or to provide assurance of the availability of funds against unanticipated cash requirements. We address the problem of determining the optimal limits of available funds a company should maintain under a revolving credit agreement. Typically a company will negotiate a legal commitment with a bank or group of banks for a specified period of time, usually one to three years, in which the bank agrees to extend credit up to a specified maximum amount. During the duration of the commitment, the bank must lend money to the company whenever the company wishes to borrow, provided the amount of money borrowed does not exceed the maximum amount noted in the agreement. The company must not be in default of any of the restrictive covenants of the agreement, such as working capital limits, compensating balances, limits on other indebtedness, etc. Although the agreement itself provides for intermediate-term financing, the agreement often takes the form of short-term (30-60-90 days) renewable notes.

The relationship between return on assets and their riskiness is one of the liveliest topics in financial literature. In his 1952 landmark article, Markowitz developed a mathematical model that captured this key financial concept. defined risk as the variance of the rate of return of a portfolio. Later, Sharpe hypothesized a positive linear relationship between expected rate of return on an asset and the risk premium associated with that asset. Subsequently, Sharpe tested this hypothesis empirically and found support for his theory. Although portfolio theory specifies the two parameters of this model as ex ante return and risk, Sharpe used ex post data for testing the risk-return relationship. designated the ex post mean rate of return obtained on an an asset as a proxy for expected return and the standard deviation of ex post annual rates of return as a surrogate for risk.

Recently, agency theory has become popular as a means of explaining the structure of contracts between various classes of economic agents. Oftentimes the contracts of interest represent sharing rules for the payoffs that result from some production activity. In the usual two-party model of the contracting problem, one party designated the principal delegates authority for decisions affecting production to another party designated the agent. Typically, the assumptions made about the consequences of the agent's actions are that they are associated with effort on the part of the agent for which the agent (but not the principal) has disutility, and that greater effort will result in higher payoffs from production in every state of nature. Moral hazard is then introduced by assuming that the principal is unable to observe the agent's effort, or to infer what effort the agent applied through an ex post observation of the payoff that results.

We examine the costs of trading restrictions by exploiting an SEC rule change eliminating an approximately 80-day restriction period in private placements for small issuers. Using a difference-in-differences specification, we find that the restriction is binding, as dollar volume increases 19 percentage points vis-à-vis proceeds, and costly, as offering discounts fall by 8 percentage points. Discounts fall more for issuers with higher information asymmetry or longer restriction periods. We account for endogenous responses to the rule change. Overall, our findings suggest that trading restrictions are costly and have large effects on firms’ cost of capital.

Two measures of investment worth: the discounted-rate-of-return and the payback method will be compared here. Many examples can be found in the literature illustrating the serious limitations of the payback method.

According to these examples, an investment proposal may be judged economically undesirable when in actual fact it is highly profitable. This happens when the annual cash flow is not equal, and the investment project promises a relatively large cash flow after the cut-off period.

We relate Schumpeter’s notion of creative destruction to asset pricing, thereby offering a novel explanation of size and value premia. We argue that small-value firms must offer higher expected returns to compensate for the risk posed by serendipitous invention activity, whereas large-growth stocks provide protection against creative destruction and receive expected return discounts. A 2-factor model that accounts for creative-destruction risk effectively explains the cross-sectional return variation of size- and book-to-market-sorted portfolios. The estimated risk compensations associated with creative destruction are substantial and statistically significant, indicating their relevance for asset pricing.

How households shift spending across firms in response to income fluctuations is an important source of firm risk. Using transaction-level data, we study how households interact with the universe of retailers following income changes. We find that income increases within and across households result in substitution toward retailers in a category that are higher quality; smaller; more profitable; and have higher labor intensity, research and development (R&D) intensity, and equity betas. Although not all shifts are economically large, they do not average out across retailers. Thus, retailer choice has implications for key financial and macroeconomic outcomes, such as aggregate profitability and labor demand.

By focusing attention on managers' concept of risk and the methods they use to measure risk, this paper attempts to lessen the disparity between current theory and practice by suggesting a method that will make IRR and NPV more generally applicable. We attempt to do this through a methodology that combines some PERT assumptions with traditionally accepted academic techniques and those used by practicing business managers to provide a probability distribution of the cumulative net present value (CPV). From these data we develop a probability distribution of the discounted payback period.

The purpose of this note is to demonstrate that the explicit introduction of consumption patterns alters the traditional relationship between expected return and variance presented by Markowitz, Tobin, Sharpe, Lintner, and others.

It is widely assumed in portfolio theory that investors are risk-averse expected-utility maximizers. There is a good theoretical reason for assuming expected-utility maximization. Such behavior is well known to be consistent with several quite plausible postulates of rationality [5]. On the other hand, the main empirical foundation for such behavior in portfolio selection appears to be the observation of diversification. Risk-averse, expected-utility maximization implies diversification in portfolio selection, and investors are observed to diversify.

In his recent paper in this Journal, Miller [3] proposed, following Adler's results [1], that “the investor exhibits decreasing absolute risk aversion with respect to expected wealth if, as increased holding σ constant, the slope of the indifference loci decreases” [3, p. 301]. He further attempted to have shown that in general the sign of () is the same as the sign of r'(W) (the derivative of the absolute risk aversion measure), but this is not proved.

In many circles the Mean Variance Capital Asset Pricing Model (MV CAPM) is synonymous with the theory of capital asset pricing. But in a single-period discrete-time model which explicitly recognizes the existence of limited liability the derivation of the MV CAPM, if it is to be consistent with the von Neumann-Morgenstern postulates of rational behavior, must be based on the assumption that all investors have quadratic utility functions. This assumption in turn implies that risky assets are inferior goods. However, if we turn to the broader class of linear risk tolerance (LRT) utility functions, for which the separation property holds, other simple two-mutual-fund CAPMs can be derived. The power utility LRT CAPMs are of particular interest as they are consistent with risky assets being normal goods.

Pricing municipal debt is a process substantially different from the valuation of corporate liabilities. Municipalities are not seized upon default. Therefore, they might own additional assets that could he made available to retire debt even when the value of pledged revenues is insufficient to do so. However, if the value of the municipality's additional assets is only observable privately, moral hazard can deter payments from these alternative revenue sources. A second consequence of lack of seizure is that the municipality survives and might return to the capital markets to raise additional funds in the future. This opens an opportunity to induce “extraordinary” payments from the value of the additional assets through multiperiod pricing controls (e.g., by following defaults with poor pricing for subsequent securities issues).

Deposit variability in banking has received substantial attention in recent empirical studies [1], [2], [3], [4], [5], and [7], Most of these efforts have been cross-section analyses of the determinants of variability. However, the impact of branching on deposit variability has not been tested in any of these studies. Wacht suggests that branching could reduce deposit variability substantially, especially if geographical dispersion could be achieved through relaxing interstate restrictions on branching [6]. In this paper, Wacht's suggestions will be subject to empirical testing for one thrift institution located in a major eastern metropolitan area. In Section I, the test methodology is presented. Data sources and empirical results are discussed in Section II, while the study is summarized and the implications for future research are discussed in Section III.

Evidence provided here suggests that investors could have identified, ex ante, portfolios that hedge against uncertainty in the prices of three major categories of consumption: food, shelter, and transportation. This finding has implications for the practical importance of multi-period capital asset pricing theories that assume investors can identify such hedge portfolios. The study also provides some surprising evidence about the usefulness of common stocks and commodity futures contracts in hedging against specific price inflation. Certain combinations of common stocks serve as effective hedges, but combinations of commodity futures contracts contribute nothing to hedging ability.

We document a strong decline in corporate-diversification activity since the late 1970s, and we develop a dynamic model that explains this pattern, both qualitatively and quantitatively. The key feature of the model is that synergies endogenously decline with technological specialization, leading to fewer diversified firms in equilibrium. The model further predicts that segments inside a conglomerate should become more related over time, which is consistent with the data. Finally, the calibrated model also matches other empirical magnitudes well: output growth rate, market-to-book ratios, diversification discount, frequency and returns of diversifying mergers, and frequency of refocusing activity.