Knowledge that Transforms

A literature survey reveals consistent excess returns after public announcements of firms' earnings. If the information in publicly-announced earnings is a public good, then these results seem inconsistent with equilibrium in the securities market: public goods, being without private cost, should earn no private return. Alternative explanations of this anomaly are considered. The most likely explanation is that earnings variables proxy for omitted variables or other misspecification effects in the two-parameter model: that the measured market portfolio is not mean-variance efficient. Similar anomalies and explanations apply to other ‘yield-surrogates’, including dividend yields and Value Line ratings.

The paper presents a valuation formula for default free bonds for a certain class of tastes when the instantaneously riskfree rate of interest follows a geometric Wiener process. Properties of the resulting term structure of interest rates are studied, and an application of the analysis to the pricing of Treasury Bills is proposed.

A series of empirically refutable generalized two parameter asset pricing models that linearly relate risk and return are identified for the power (and quadratic) utility members of the linear risk tolerance capital asset pricing models. Five possible power utility models and the mean variance model are tested to determine whether one model might provide a more accurate description of security pricing. The major empirical result is that the data do not allow us to distinguish between the models.

The Black-Scholes option pricing model, as generalized for dividend payments by Merton, is used to calculate implied variances of future stock returns. These variances are found to be better predictors of future stock return variances than those obtained from historic stock price data. A trading strategy is developed that exploits the informational content of the implied variances. The trading strategy, contrary to the efficient market hypothesis, produces abnormally high returns.

This is the first part of a study about common stock returns around split events (part I) and dividend change events (part II) as revealed in the 1947–1967 experience of the New York Stock Exchange. Competing estimates of abnormal returns (residuals) are obtained and compared. Trading rules, involving fixed and variable monthly investments, are tested for profitability. Trading triggered by split proposals, dividend increases and, in particular, dividend decreases yields significant residuals and would thus point to market inefficiencies. Some drifting in the samples' average risk and residual behavior is explained in terms of risk measurement and two-factor market model characteristics. Residuals hardly change when risk adjustment is based on variance of returns in lieu of beta. The question is raised that the residual approach may at times prove unduly refined. Yet a multi-method approach to risk-return studies seems advisable because the odd behavior found one way can often be fruitfully explained or confirmed through comparisons with results obtained another way. In part I below outstanding features are: (1) the stocks' average excess returns in the three months following split proposals differ from zero but the anomaly hinges on the results for a rather short time sub-period; (2) numerous pitfalls in measuring and interpreting stocks' residuals are brought into light. Part II is the subject of a companion article in this issue of the Journal.

Numerous studies observe abnormal returns after the announcement of quarterly earnings. Ball (1978) suggests those returns are not evidence of market inefficiency, but instead are due to deficiencies in the capital asset-pricing model. This paper tests whether abnormal returns are observed when steps are taken to reduce the effect of deficiencies in the capital asset-pricing model. Significant abnormal returns are observed, but do not cover the transactions costs unless one can avoid direct transactions costs (e.g., a broker). The paper also investigates whether those abnormal returns can be attributed to a deficiency in the capital asset-pricing model. The conclusion is they cannot.

This paper investigates the extent to which discounts and premiums provide information about future expected rates of return on closed-end investment company shares. It is found that discounted fund shares, adjusted for risk, tended to outperform the market in the period 1940 to 1975. Funds selling at a premium appear to have been bad investments over the same time period. On the basis of these results it is argued that the two-parameter capital asset pricing model does not describe the return generating process of closed-end funds. Other potential areas to search for breakdowns in two-parameter pricing are suggested.