This statement presents the usual perception of bond risk. It is striking in that it does not discuss what is, from a portfolio theoretic view, the risk of a bond––the covariance of its return with the returns of other assets. This is in contrast to the typical discussion of the riskiness of common stocks, where we find some discussion of systematic risk and the role it plays in determining equilibrium expected security returns.

The past two decades have seen a proliferation of mathematically sophisticated portfolio selection models. Of these, the mean variance (MV), expected utility, and growth optimal (GO) models have received the bulk of attention.

Empirical tests of the Sharpe [36]–Lintner [23]–Black [3] Capital Asset Pricing Model (CAPM) have generally concluded that there is a positive, approximately linear, trade-off between average return and systematic risk (beta) for portfolio returns of common stocks. Most of the empirical studies, however, have reported data for short, usually monthly, time intervals. Exceptions to this rule include Blume and Friend [8] and Sharpe [38, pp. 289–292]. Their data provide evidence that long-term wealth ratios are concave, possibly nonmonotonic, functions of beta. These data are surprising since, if returns are intertemporally independent and the linear return model of CAPM is correct, expected multiperiod terminal wealth is a convex, monotone increasing function of beta. The results of this paper provide a theoretical framework for interpreting the long-term empirical data which does not violate the notion of a monotone increasing expected terminal wealth-beta relationship.

As is shown in the financial literature, the assumption of perfect and costless information often leads to the conclusion that corporate financial decisions are inconsequential to the value of the firm (e.g., Stiglitz [20] and Fama [6]). This conclusion seems to be in direct contradiction with the observed behavior of corporations that allocate real resources to implement financial policies. The gap between theory and observed behavior is bridged by introducing various frictions and market imperfections. A growing number of studies examine the optiraality of financial decisions when the assumption of perfect and costless information is replaced by allowing for informational asymmetry. The asymmetry is assumed to exist between corporate insiders who possess superior information about the firm's future earnings prospects and outside investors. The emphasis in this literature is on the ability of financial instruments to serve as signaling devices through which the true value of the firm can be revealed to the market without moral hazard or disclosure of confidential information. Although the signaling process is typically considered to be costly, it is advocated that firms may be better off if they employ this mechanism rather than reveal reliable, but confidential information, or not disclose at all.

The recent experience of increased volatility of exchange rates among major currencies coupled with highly unstable price levels necessitates a more fundamental understanding of exchange risk. This necessity is further enhanced by the increased internationalization of consumption, investment, and other aspects of economic activity.

This paper generalizes the past signaling literature from one variable to many. Multivariate models have been studied in the general rational expectations literature (e.g., Allen [1], Kraus and Sick [3]), but this appears to be the first multivariate signaling application. (Here, I distinguish signaling from rational expectations literature by the fact that agents may attempt to promulgate, suppress, or add noise to signals.) Talmor studies signaling models which are fully revealing (i.e., for which, in equilibrium, the values of the signaled parameters are correct).

Edward Miller [5], expanding on the work of Williams [8], Smith [6], and Lintner [4], has proposed a direct relationship between a stock's “risk” and its “divergence of opinion.” Under conditions of uncertainty, potential investors in a stock arrive at different assessments of expected return. Thisvariation in expectations is characterized as the stock's divergence of opinion. Miller argues persuasively that at a point in time a stock's price does not reflect the expectations of all potential investors, but rather the expectations of only the most optimistic minority who are trading the issue. As long as this minority can absorb the entire supply of stock, an increase (decrease) in divergence of opinion-leaving the average expectation unchanged-will increase (decrease) the market clearing price.

The form of the Pareto optimal general insurance contract has been investigated by Borch [5], Arrow [3], and Raviv [16]. This paper extends their work to the consideration of the optimal investment portfolio insurance contract. This is a contract whose payoff depends upon the investment performance of some specified portfolio of common stocks. Portfolio insurance differs from general insurance in two important ways. First, investment portfolio insurance lacks the property of stochastic independence between losses on different contracts which is characteristic of general insurance, and this has led some actuaries to question whether portfolio insurance contracts should be sold in view of the risks they pose for the solvency of insurance companies. Recent developments in the theory of option pricing suggest, however, that under certain assumptions an insurance company will be able to eliminate the risks associated with portfolio insurance contracts by following an appropriately defined investment strategy. Secondly, there exists a market for the pricing of investment risks, the securities market; and, under appropriate assumptions, the equilibrium price of portfolio insurance contracts may be determined without specification of the preferences of insurance companies. This permits consideration of insurance company preference functions to be dispensed with, in marked contrast to the earlier literature concerned with general insurance, which treats insurance company preferences symmetrically with those of the insurance purchaser. In addition, since the characteristics of the insured portfolio are known to the insurer, and the performance of the portfolio is beyond the control of the insured, portfolio insurance is not prone to the problems of adverse selection and moral hazard which are liable to arise in general insurance.

The familiar two-parameter model for portfolio decisions, attributed to Markowitz [11], has individuals maximizing an objective function, ϕ [E(Y), V(Y)], of mean and variance of end-of-period wealth, subject to a constraint imposed by initial wealth. In the usual version there is an arbitrary number, n, of risky assets with stochastic end-of-period values (price plus dividend) represented by the vector X with exogenously given mean vector μ and nonsingular variance matrix σ. There is also one riskless asset, whose certain end-of-period value per dollar invested is p. Final wealth, as constrained by initial wealth, W, is given by Y = WP + a' (X – OP), where a and P are vectors of risky asset quantities and prices. Assuming ϕE > 0 (wealth preference), ϕV < 0 (risk aversion), and that the Hessian of $ is negative and semidefinite, portfolio optimum calls for ϕE(μ − OP) + 2ϕVσa = 0, or

Analysis of the growth record of many economies indicates that foreign capital is an important factor in the process of economic development. For many developing countries, a continuing flow of foreign funds is necessary if desired growth targets are to be achieved. These funds are most likely to be in the form of loans rather than grants. This link between economicdevelopment and debt accumulation manifested itself in the enormous growth of less developed countries’ (LDCs) external indebtedness in recent years, especially after the oil crisis of 1973.

A recent issue of the Journal of Financial Economics (June/September 1978) is devoted to reporting anomalous evidence regarding market efficiency. This study may qualify under the same heading. Here we examine the market response to information about firms whose future is assessed as being extremely problematic.

In the last few years, several innovations have appeared in mortgage finance which are designed to improve the flow of funds into mortgage lending. Among this group, The Federal National Mortgage Association (FNMA) remains the intermediary which handles the largest share of most mortgage lenders' placements. As a private corporation chartered by Congress and owned by stockholders, FNMA provides a national secondary market facility for government-backed (FHA/VA) and conventional mortgages. Through its secondary market operations, FNMA furnishes a source of liquidity for mortgage lenders with the major portion of this support provided through the Free Market System (FMS) auctions. Through its issuance of forward purchase commitments, the FNMA assures lenders of a permanent investor (at a set yield) for specified periods of time, regardless of changing money market and housing conditions.

Cash concentration is the task of moving funds from depository banks into the central cash pool. It is useful to structure cash concentration by dividing it into two major problems––management and design. Management is the day-to-day operation of the cash concentration system once it is designed. Design is specifying the structure of the cash concentration system.

The adequacy of the capital asset pricing models (CAPM) of Sharpe [27], Lintner [17], and Black [4] as empirical representations of capital market equilibrium is now seriously challenged (for example, see Ball [1], Banz [2], Basu [3], Cheng and Graver [8], Gibbons [15], Marsh [18], Reinganum [22], and Thompson [20]). Yet, the influence of earlier empirical studies (such as Black, Jensen, and Scholes [5] and Fama and MacBeth [11]) still remains; the current consensus seems to be that a security's beta is still an important economic determinant of equilibrium pricing even though it may not be the sole determinant. In light of the recent empirical evidence, however, the claim that a security's beta is an important determinant of equilibrium pricing should be reexamined.

The coefficient of variation (CV) in investment returns is often presented in introductory finance texts as a measure of project risk [7, 9, 13, 15]. Curiously, the resulting mean-coefficient of variation (MCV) efficiency criterion is usually casually proposed as an alternative to the more widely recommended mean-standard deviation (MSD) definition of efficiency, as if MCV possessed an obvious intuitive appeal for some investors or some investment situations. The pervasiveness of references to CV as a risk measure is perplexing in light of the absence of utility theoretic underpinnings, especially by contrast with the substantial theoretical effort underlying the MSD notion of efficiency [3, 6, 8, 10, 11, 12].

In recent years a major controversy has formed in the finance literature regarding the empirical evidence of the informational content of dividends. Despite considerable support for the position of dividend nontriviality by various studies, the work by Watts [13] represents a formidable challenge. Because of the close proximity of the firm's earnings and dividend announcement dates, the major issue of the dispute has centered on the identification and control of contemporaneous earnings information. In an attempt to settle this controversy, the present study evaluates and extends Watts' methodology.

Over the past decade, a number of papers [1, 2, 3, 6, 7, 9] have explored the relative merits of negotiation versus competitive bidding in the underwriting of corporate bonds, particularly bonds issued by public utilities. Interest in this subject has been stimulated principally by an important public policy issue—namely, the SEC's posture vis a vis its Rule U–50. Originally promulgated in 1940, this rule required competitive bidding on certain classes of utility bonds. In 1974, however, it was “temporarily” suspended on the grounds that chaotic conditions in the market for these securities called for more flexibility in the way issues could be underwritten. While this suspension continues in effect, Rule U–50 could be reinstated at any time by the SEC.

In recent years much research has centered upon whether yield differentials between bonds which differ in default risk vary systematically over the business cycle. Theory suggests that during a cyclical upswing the yield differential (or risk premium) narrows, while during a downswing the differential widens. The cyclical behavior of yield spreads is well documented in the corporate bond market [4, 8, 12, 16]. This effect has only recently been given attention in the tax-exempt bond market [1, 11]. In addition, the municipal bond market may be segmented. If tax-exempt borrowers and investors are unable to substitute between tax-exempt securities of varying default risk, changes in the relative supply of and demand for these classes of securities could produce systematic fluctuations in tax-exempt yield differentials. These effects could be produced by regulatory statutes which require that banks purchase high-grade securities and the fixed nature of bond ratings.

In a world of heterogeneous investors, a competitive financial market has two major functions. First, it is the mechanism by which ownership of the existing supply of risky assets is distributed among investors. This is the role which is analyzed in detail by the standard Capital Asset Pricing Model (CAPM) and its many extensions. The second important market function is to aggregate the diverse information held by different investors into a single price. Most versions of the CAPM eliminate the information aggregation function by assuming that investors hold homogeneous beliefs with respect to the probability distribution of asset returns. Exceptions which deal with some aspects of the problem are Lintner [7], Grossman [4], Grossman and Stiglitz [5], and Figlewski [1, 3 ].

Much of modern portfolio theory rests on conclusions drawn from the original form of the Capital Asset Pricing Model. Fundamental to the conclusions of this model is the assumption of perfect competition among investors; i.e., all investors possess approximately the same small amount of wealth such that equilibrium price cannot be influenced significantly by the demand of any of the investors. Today's security market, however, is characterized by individuals and large institutional investors such as insurance companies and investment funds. Although institutions represent a very small fraction of all investors in the market, institutional investors in 1977 held 34.3 percent of all outstanding stock. By the very magnitude of the dollar transactions effected by these large investors, prices can and are affected dramatically. Because today's security market is composed of investors exhibiting extreme differences in wealth, the United States securities market probably is not perfectly competitive as assumed in portfolio theory. Consequently, investment theory must be extended to reflect vast wealth differences among investors. To achieve this end, modifications are made to the original Capital Asset Pricing Model. Equilibrium conditions are examined and conclusions are drawn as to how portfolio theory must be altered to include price affecting ability by a segment of the investors in the market.