Knowledge that Transforms

Anthony F. Herbst, Some Empirical Evidence on the Determinants of Trade Credit at the Industry Level of Aggregation, The Journal of Financial and Quantitative Analysis, Vol. 9, No. 3 (Jun., 1974), pp. 377-394

Intuitively, a risk averter diversifies between two investments if there is some sort of negative interdependence. In [3], Samuelson gives the example of buying shares in a coal company and an ice company. It is of interest to characterize this concept of negative interdependence more sharply.

The large amount of foreign direct investment by U. S. firms in recent years suggests that such firms had a high internal rate of return on investment abroad. In this paper we attempt to explain this high rate of return. We conclude that direct investors tend to be in research-intensive industries and that their profitability is associated with research and development, rather than with direct investment itself. By investing abroad, or exporting, they increase the expected return to research activity. Thus, the internal rate of return on foreign direct investment exceeds average rates of return observed in foreign economies. Since direct investors in manufacturing are typically research-intensive, this result suggests why capital may flow from countries with high rates of return to those with lower observed rates of return.

The Markowitz-Sharpe market model has been extensively applied to the study of price behavior of American common stocks. In this paper an international market model will be used assuming that the return on any security is a linear function of the return on the world market portfolio. A justification for this approach lies in the International Asset Pricing Model (IAPM) proposed by Solnik [14] and [15]. This market model is by no means the only stochastic process of security returns consistent with the IAPM, but it is the most simple and straightforward extension of the traditional approach to domestic markets.

Previous empirical studies of mutual fund performance relative to market performance were conducted using two- and three-moment analysis. This study has applied first-, second-, and third-degree stochastic dominance principles to investigate the same question. Our results support the earlier Sharpe study and oppose the recent Arditti work. From the investor's standpoint, mutual fund performance was inferior to market performance over the period 1954–1963.

One of the phenomena on Wall Street during the sixties was the new issues market. During the decade new issues became a popular investment alternative, particularly in the bull markets of 1962, 1966, and 1968. The height of enthusiasm occurred in the hot new issues market of the fiscal year 1968–1969 when 2, 171 issues were offered to the public. This interest in new issues was followed by studies such as Reilly and Hatfield [12], McDonald and Fisher [9], the SEC [13], and others, all of which show that there is a downward bias in the issue price of new issues. Why this downward bias is present was treated later by Logue [5]. Although these studies also suggest that there is a difference in the pricing behavior by individual underwriters, none of the previous studies has addressed itself specifically to this point.

The Markowitz model for the efficient diversification of investments [12] has, over the years since its original formulation, provided the basis for many investigations into the question of portfolio selection. Amongst the more notable contributions to the theory are the works of Fama [6] and Mandelbrot [11], Smith [17], Latané [10], Arditti [1], and Blume [2].

This study's purpose was to construct a performance criterion for New York Stock Exchange specialists which relates to their ability to affect price variability. It was emphasized that the price-setting behavior of the specialists, at times when trading imbalances prevail in the market, is the most important aspect of their performance. Their performance in this dimension may or may not be associated with their willingness to supply immediacy services to small orders. While the bid-ask spread is the correct variable to measure when the latter is considered, price variability or, more precisely, the functional relationship between price changes and trading imbalances is the variable to be measured when the price-setting behavior is of interest. While the experiment to evaluate the price-setting behavior of NYSE specialists using publicly available data may be considered a pioneer study, other studies have estimated the determinants of the bid-ask spread. The contributions of this study to the analysis of the spread can be summarized as follows: (a) observing an independent “specialist effect” on the size of the spread, (b) estimating the spread-volume relationships using a simultaneous system, and (c) estimating the association between the specialists' performance on both spread and price dimensions of their activity. The finding of this study is that there is a positive correlation between the quality measure of performance on both dimensions.

Revised May, 1973.

The normative procedures of Markowitz [4], Sharpe [6], and others can be utilized to determine an optimal portfolio (set of security holdings) given estimates of risk, relevant constraints, and expected returns on securities. Building on these foundations, the positive models of Sharpe [7], Lintner [3], Mossin [5], and others assume that investors form portfolios as if they were following such procedures. We observe considerable differences in portfolio composition, some of which undoubtedly stem from differences in expectations. Yet the predictions of most investors are either made implicitly or, if made explicitly, are jealously guarded and hence cannot be observed by outsiders.