Knowledge that Transforms

We estimate the extent to which various assets were hedges against the expected and unexpected components of the inflation rate during the 1953–1971 period. We find that U.S. government bonds and bills were a complete hedge against expected inflation, and private residential real estate was a complete hedge against both expected and unexpected inflation. Labor income showed little short-term relationship with either expected or unexpected inflation. The most anomalous result is that common stock returns were negatively related to the expected component of the inflation rate, and probably also to the unexpected component.

In this paper, we develop a Capital Asset Pricing Model (CAPM) using a mean-lower partial moment framework. We explicitly derive formulae for the equilibrium values of risky assets that hold for arbitrary probability distributions. We show that when the probability distributions and portfolio returns are either normal, stable (with the same characteristic exponent between 1 and 2 and the same skewness parameter, not necessarily zero), or Student-t distributions, our CAPM reduces to the traditional mean-scale CAPM's. Consequently, since the traditional equilibrium models are special cases of our model, the mean-lower partial moment framework is guaranteed to do at least as well in explaining market data. As an application of our theory, we derive an acceptance criterion for capital investment projects and note that corporate finance theory results developed, for example, in the well-known mean- variance framework carry over to the mean-lower partial moment framework.

Sometimes it pays to exercise an American-type call option prematurely, just prior to a cash emission by the underlying security. Such an option can be expressed as a combination of three European-type options whose valuation formulae are known.

This paper uses the Capital Asset Pricing Model to link the financial policy of the firm with the firm's real decisions including output, input mix, and investment. Whereas the M-M leverage theorems were derived for a given set of real decisions, this paper considers the impact of leverage on firm optimization when interest is tax-deductible. In general, leverage impacts upon factor proportions, capital stock, and output decisions. In the final proposition, the author demonstrates that the ‘cost of capital’ need not decline with leverage even in perfect capital markets and with default-free debt.

This paper finds that extending popular two-parameter models of capital market equilibrium to allow for the existence of non-marketable human capital does not provide better empirical descriptions of the expected return-risk relationship for marketable securities than those that come out of the simpler models. This conclusion arises from the fact that relationships between the return on human capital and the returns on various marketable assets are weak, so that the model that includes human capital leads to estimates of risk for marketable assets indistinguishable from those of the simpler models.

The efficient market, martingale model of security price movements requires that the arrival of new information be promptly arbitraged away. A necessary and sufficient condition for the existence of an arbitraged price is that statistical dependence among prices must decrease very rapidly. If persistent statistical dependence is present, the arbitraged price changes do not follow a martingale and should have an infinite variance. Using a technique for detecting long-term dependence, called R/S analysis, 200 daily stock return series are studied; many series are characterized by long-term dependence. Thus, in the presence of long-term dependence, the martingale model does not hold. Also, the distribution of security returns is non-normal stable Paretian as opposed to Gaussian.

This paper provides an analysis of the choice of method for raising additional equity capital by listed firms. Examination of expenses reported to the SEC indicates that rights offerings involve significantly lower costs; yet underwriter are employed in over 90 percent of the offerings. The underwriting industry, finance textbooks, and corporate proxy statements offer several justifications for the use of underwriters. However, estimates of the magnitudes of these arguments indicate that they are insufficient to justify the additional costs of the use of underwriters. The use of underwriters thus appears to be inconsistent with rational, wealth-maximizing behavior by the owners of the firm. The paper concludes with an examination of alternate explanations of the observed choice of financing method.

This paper is an empirical investigation into the extent to which transactions costs and taxes influence individual investors' portfolios. Using actual portfolio and demoraphic data made available by the Individual Investor Research Project at Purdue University, this study finds evidence of a significant dividend clientele effect. Reasonable proxy variables used to measure time preferences and tax rates in part explain the cross sectional variability of investors' portfolio dividend yields. The variables that are most important in influencing the individual's dividend decision are age, and a measure of the investor's differential tax rate on dividends and capital gains.

This paper provides empirical estimates of the stock market reaction to tender offers, both successful and unsuccessful. The impact of the tender offer on the returns to stockholders of both bidding and target firms is examined. The evidence indicates that for the twelve months prior to the tender offer stockholders of bidding firms earn significant positive abnormal returns. In the month of the offer, only successful bidders earn significant positive abnormal returns. Stockholders of both successful and unsuccessful targe firms earn large positive abnormal returns from tender offers, and most of these returns occur in the month of the offer. For all classes of firms, there is no significant post-offer market reaction. The market reaction to ‘clean-up’ tender offers is also estimated and target stockholders again earn significant positive abnormal returns.

Stock exchange seats are important assets for securities brokers since they provide access to centralized secondary trading markets for corporate securities at a reduced cost. This paper provides empirical evidence on the dynamic behavior of monthly New York and American Stock Exchange seat prices over the 1926–1972 period. Specifically, evidence is presented which: (a) is consistent with a multiplicative random walk model for seat prices; (b) indicates that unexpected changes in the prices of exchange-listed stocks or in the volume of shares traded on the exchange are important new information about the value of seats in each month; and (c) indicates that the market for seats is efficient in assimilating new information and quickly incorporates new information into the prices of seats. In addition, we examine the effect of the infrequent trading of seats on the statistical properties of the models.