Knowledge that Transforms

The author presents a self-contained exposition of selected topics in the theory of financial markets with applications to corporate finance. The book covers only topics sanctioned by tradition. About one-quarter of the book is devoted to the one-period model with certainty. Half the book deals with the one-period model with uncertainty, and the remaining quarter with multiperiod models with uncertainty, both discrete and continuous. The one-period model with certainty starts with topics from the standard theory of the consumer and discusses consumer preferences and their representation by utility functions. The author then defines arbitrage trading strategies and uses the assumed properties of preferences to show that equilibrium in this model excludes arbitrage trading strategies. In the absence of arbitrage trading strategies all securities earn the same rate of return. The price functional, which maps terminal cash flows into initial prices, is additive, and the irrelevance of corporate financial structure and dividend policy follows from the additivity of the price functional.

Journal Article Market Trading Structures and Asset Pricing: Evidence from the Treasury-Bill Markets Get access Avraham Kamara Avraham Kamara University of Washington Search for other works by this author on: Oxford Academic Google Scholar The Review of Financial Studies, Volume 1, Issue 4, October 1988, Pages 357–375, https://doi.org/10.1093/rfs/1.4.357 Published: 14 March 2015

This article suggests that the lack of use of rights offerings in the United States, a phenomenon referred to as the equity underwriting paradox, can be explained by transaction costs. A sample of underwritten rights offerings provides support for the explanation. Firms making underwritten rights offerings paid lower underwriter fees but incurred significantly larger price drops just prior to the offering than did firms making underwritten offerings. Further analysis reveals that the underwritten-rights-offering price concessions are a form of transaction cost that is not found in underwritten public offerings.

This article investigates the structure on preferences required to derive Ross's arbitrage pricing theory (APT). It is shown that only ordinal preferences are required. In particular, the APT does not require that agents possess preferences representable as risk-averse expected utility functions. This characteristic of the APT is not shared by the standard equilibrium-based capital asset pricing models.

Most modern financial research can be characterized as theoretical or empirical, or a mix of the two. Theoretical finance can be divided in the way that theoretical economics is. Neoclassical research stems from the neoclassical economics of perfectly competitive markets that have no imperfections or frictions, such, as taxes, transaction costs, externalities, or information asymmetries. By definition, imperfect markets research includes all other topics, such as the study of taxes, institutions, and topics stemming from information economics. Darrell Duffie's new book is an introduction to neoclassical finance that emphasizes topics in the intersection of theoretical finance and the mathematical economics of general equilibrium. The book is designed to take the student from first principles to the frontiers of finance-oriented general equilibrium theory. The book contains a rigorous introduction to the necessary topics in probability and stochastic control and is a good source for that material. It also contains a good summary of general equilibrium theory, including the required background mathematics. Each theorem from the general equilibrium literature is presented in a form that is general enough to be applicable to continuous-time models in finance but is as simple as possible given that level of generality. Other variations are mentioned in the literature reviews at the end of each section.

Journal Article A Message from the President of the Society for Financial Studies Get access Joseph Williams Joseph Williams New York University Search for other works by this author on: Oxford Academic Google Scholar The Review of Financial Studies, Volume 1, Issue 1, January 1988, Pages 1–2, https://doi.org/10.1093/rfs/1.1.1 Published: 03 April 2015

We examine the sale of equity within the context of a model of negotiation between a firm and a less well informed purchaser. We introduce a simple form of negotiation by allowing the firm to set the price of the issue and by assuming that the purchase is a financier-underwriter who acts strategically. This transaction is analyzed as a noncooperative game, and we identify sequential equilibria that are consistent with observed behavior: namely that negotiations occasionally fail, that market reactions to equity offers are not uniformly negative, and that equity placements are often underpriced.

The role of ordinary options in facilitating the completion of securities markets is examined in the context of a model of contingent claims sufficiently general to accommodate the continuous distributions of asset pricing theory and option pricing theory. In this context, it is shown that call options written on a single security approximately span all contingent claims written on this security and that call options written on portfolios of call options on individual primitive securities approximately span all contingent claims that can be written on these primitive securities. In the case of simple options, explicit formulas are given for the approximating options and portfolios of options. These results are applied to the pricing of contingent claims by arbitrage and to irrelevance propositions in corporate finance. The role of complete contingent-claims markets in the optimal allocation of risk bearing is well known [Arrow (1964) and Debreu (1959)] and is the cornerstone of the economic theory of financial markets [Mossin (1977)]. As a consequence, it becomes important from a practical as well as a scholarly perspective to determine how complex the securities markets must be in order to achieve the allocational efficiencies of complete markets. The literature on this question has grown to be sizable. Much of this literature has been reviewed in John (1981, 1984) and Amershi (1985). A seminal contribution concerning the complexity of complete securities markets was made by Ross (1976) in analyzing the role of conventional options in com-

In a model of the firm in which insiders are privately informed of the firm's prospects and investment is endogenous, this article shows the existence of coarse dividend-signaling equilibria: Dividends partition the space of possible prospects of the firm, and changes in dividends reflect "broad", or nonincremental, changes in these prospects. These equilibria are shown to exist under general preference and technology structures, and it is argued that they closely match the following "anomalous" empirical features of corporate dividend payouts: Dividend changes have nontrivial information effects, yet dividends are smoothed (in a world with cyclic prospects), and dividends are poor predictors of future earnings. Furthermore, in performing comparative statics, this article derives cross-sectional and time-series restrictions on the relation of dividend smoothing to observable firm attributes.

A restriction to nonnegative wealth is sufficient to preclude all arbitrage opportunities in financial models that have no arbitrage in limits of simple strategies. Imposing nonnegative wealth does not constrain agents from making the choice they would make under the standard integrability condition. These conclusions do not depend on whether markets are complete.