The sphere of modern financial economics encompases finance, micro investment theory and much of the economics of uncertainty. As is evident from its influence on other branches of economics including public finance, industrial organization and monetary theory, the boundaries of this sphere are both permeable and flexible. The complex interactions of time and uncertainty guarantee intellectual challenge and intrinsic excitement to the study of financial economics. Indeed, the mathematics of the subject contain some of the most interesting applications of probability and optimization theory. But for all its mathematical refinement, the research has nevertheless had a direct and significant influence on practice. It was not always thus. Thirty years ago, finance theory was little more than a collection of anecdotes, rules of thumb, and manipulations of accounting data with an almost exclusive focus on corporate financial management. There is no need in this meeting of the guild to recount the subsequent evolution from this conceptual potpourri to a rigorous economic

The sphere of modern financial economics encompases finance, micro investment theory and much of the economics of uncertainty.As is evident from its influence on other branches of economics including public finance, industrial organization and monetary theory, the boundaries of this sphere are both permeable and flexible.The complex interactions of time and uncertainty guarantee intellectual challenge and intrinsic excitement to the study of financial economics.Indeed, the mathematics of the subject contain some of the most interesting applications of probability and optimization theory.But for all its mathematical refinement, the research has nevertheless had a direct and significant influence on practice.It was not always thus.Thirty years ago, finance theory was little more than a collection of anecdotes, rules of thumb, and manipulations of accounting data with an almost exclusive focus on corporate financial management.There is no need in this meeting of the guild to recount the subsequent evolution from this conceptual potpourri to a rigorous economic theory subjected to systematic empirical examination.1 Nor is there a need III -2on this occasion to document the wide-ranging impact of the research on 2 finance practice.I simply note that the conjoining of intrinsic intellectual interest with extrinsic application is a prevailing theme of research in financial economics.The later stages of this successful evolution has however been marked by a substantial accumulation of empirical anomalies; discoveries of theoretical inconsistencies; and a well-founded concern about the statistical power of many of the test methodologies.3Finance, thus finds itself today in the seemingly-paradoxical position of having more questions and empirical puzzles than at the start of its modern development.To be sure, some of the empirical anomalies will eventually be shown to be mere statistical artifacts.However, just as surely, others will not be so easily dismissed.I see this new-found ignorance in finance as mostly of the useful type that reflects our "...express recognition of what is not yet known, but needs to be known in order to lay the foundation for still more knowledge." 5Anomalous empirical evidence has indeed stimulated wide-ranging research efforts to make explicit the theoretical and empirical limitations of the basic finance model with its frictionless markets, complete information, and rational, optimizing economic behavior.Although much has been done, this research line is far from closure.Some hold that the paradigm of rational and optimal behavior must be largely discarded if knowledge in finance is to significantly advance.Others believe that most of the important empirical anomalies surrounding the current theory can be resolved within that traditional paradigm.Whichever view emerges as the dominant theme in finance, our understanding of the subject promises to be greatly enriched by these research programs.

In models where both investors and securities are subject to differential taxation, there may be no set of prices that rule out infinite gains to trade, or "tax arbitrage."This paper characterizes the joint restrictions on financial-asset returns and investors' tax schedules that preclude tax arbitrage in the absence of short-sale constraints.The authors show that, if there exists any configuration of marginal tax rates on investors' tax schedules that rule out infinite gains to trade, then "no-tax-arbitrage" prices will exist.They also show that the existence of "no-tax-arbitrage" prices ensures the existence of equilibrium prices. THE EFFECTS OF DIFFERENTIAL taxation on the equilibrium prices of financial assets have attracted much attention from financial economists in recent years.Otherwise identical securities that contribute to taxable income to different degrees will, in general, be valued differently by taxable investors.As a result, tax considerations have been useful in helping explain the effect of dividend yield on stock returns,' the effect of coupon levels and term to maturity on bond prices,2 the timing of investors' portfolio transactions,3 and the observed capital structures of firms.4While a rich set of observed behaviors can be better understood by reference to differential taxation, there are well-known difflculties in dealing with taxes in a general-equilibrium setting.To clear markets, relative prices must reflect the marginal rates of substitution of all agents simultaneously.When tax rates differ across investors, however, this condition can be impossible to achieve.To illustrate, consider a world of perfect certainty with two assets: a tax-exempt municipal bond and a taxable government bond.To equate marginal rates of substitution, the rate of return on the government bond, rg, must equal that on the municipal, rm, "grossed up" by one minus the investor's marginal tax rate, ti; that is, rg = rm/( 1 -ti).If there are investors in more than one tax bracket, this condition will obviously be impossible to satisfy for all of them simultaneously.

ABSTRACT In models where both investors and securities are subject to differential taxation, there may be no set of prices that rule out infinite gains to trade, or “tax arbitrage.” This paper characterizes the joint restrictions on financial‐asset returns and investors' tax schedules that preclude tax arbitrage in the absence of short‐sale constraints. The authors show that, if there exists any configuration of marginal tax rates on investors' tax schedules that rule out infinite gains to trade, then “no‐tax‐arbitrage” prices will exist. They also show that the existence of “no‐tax‐arbitrage” prices ensures the existence of equilibrium prices.

ABSTRACT In this paper, we implement a methodology to identify and measure premia in the pricing of forward foreign exchange that involves application of signal‐extraction techniques from the engineering literature. Diagnostic tests indicate that these methods are quite successful in capturing the essence of the time‐series properties of premium terms. The estimated premium models indicate that premia show a certain degree of persistance over time and that more than half the variance in the forecast error that results from the use of current forward rates as predictors of future spot rates is accounted for by variation in premium terms. The methodology can be applied straightforwardly to the measurement of unobservables in other financial markets.