Knowledge that Transforms

This paper analyzes investment rules for various organizational forms that are distinguished by the characteristics of their residual claims. Different restrictions on residual claims lead to different decision rules. The analysis indicates that the investment decisions of open corporations, financial mutuals and non-profits can be modeled by the value maximization rule. However, the decisions of proprietorships, partnerships, and closed corporations cannot in general be modeled by the market value rule.

In a multivariate regression model relating individual returns to the market return, CAPM implies non-linear restrictions on the parameters. Several asymptotically valid tests of these restrictions have been suggested. The existing Monte Carlo evidence shows that some of these tests are unreliable for reasonable sample sizes, but does not indicate well which tests are reliable. This paper reports the results of an extensive Monte Carlo experiment. Shanken's CSR test and Jobson and Korkie's corrected likelihood ratio test are quite accurate in all cases we consider.

This paper considers the problem of forming a hedge when there are perceived profit opportunities. We show that the option price obeys a modified Black and Scholes equation. Iterative methods yield the appropriate hedge ratio.

This paper analyzes the empirical behavior of stock-return volatilities prior to and subsequent to the ex-dates of stock splits. The evidence demonstrates rather unambiguously that there is, on the average, an approximately 30% ‘arbitrary’ increase in the return standard deviations following the ex-date. The increase holds for both daily and weekly data, and it is not temporary. No explanatory confounding variables, such as institutional frictions affecting price observations, have been identified. We view the findings as being essentially inconsistent with the notion of ‘rational pricing’.