Knowledge that Transforms

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This paper tests the Value Additivity Principle (VAP) of financial assets with the pricing of Standard Oil securities in 1912. The results are somewhat mixed: the VAP does not generally describe the daily prices of equivalent Standard Oil portfolios, but it accurately describes their average market values; and the portfolio values display convergent adjustment behavior that tends to equalize them quite rapidly. On balance, these findings are consistent with the VAP.

Most research dealing with portfolio selection under uncertain inflation is carried out by assuming either one of the following two approximations: a linear or a quadratic approximation. In this paper, we analyze the general case, namely assume that the nominal return is the product of the real return and one plus the rate of inflation. We demonstrate that the general analysis leads to the following results that are not found in the two approximations: (1) even if we assume that nominal returns are independent of inflation, the nominal and real efficient sets will not necessarily coincide. Mean-Variance (M-V) analysis leads to a nominal efficient set, that is, a subset of the real M-V efficient set, whereas the opposite holds assuming investors maximize expected utility of real wealth. (2) Similar results are obtained when real returns are independent of inflation (the Fisher hypothesis). Assuming normality of nominal returns, we derive the CAPM in real terms or its zero beta counterpart.

In this paper, we compare the robustness in application of the Gaussian assumption of security return distributions to the robustness of the general stable assumption. Using actual stock return data to simulate the “real world, ” a stock market is constructed in which stock returns conform to a Gaussian distribution as well as to a stable Pareto-Levy distribution. Using these two sets of stock returns, efficient frontiers are generated under both assumptions of parametric environments. It is shown that the Gaussian assumption, and its incumbent statistical techniques, is preferable to the general stable assumption.

Ivan E. Brick, Lawrence Fisher, Effects of Classifying Equity or Debt on the Value of the Firm Under Tax Asymmetry, The Journal of Financial and Quantitative Analysis, Vol. 22, No. 4 (Dec., 1987), pp. 383-399

Many futures contracts contain a delivery option, which allows the short position a choice to deliver one of several varieties of a commodity. Several authors have argued that delivery options can have considerable value. For a forward contract with a delivery option, this paper shows that a continuously adjusted hedge will drive the value of the delivery option towards zero, assuming perfect and frictionless markets.

Nai-Fu Chen, Thomas E. Copeland, David Mayers, A Comparison of Single and Multifactor Portfolio Performance Methodologies, The Journal of Financial and Quantitative Analysis, Vol. 22, No. 4 (Dec., 1987), pp. 401-417

In this paper, tests are conducted for the presence of unit roots in the autoregression representation of foreign exchange currency futures price series. The results obtained from five different currency futures over the 1977–1983 period suggestthat foreign currency futures rates have autoregressive representations with a singleunit root (i.e., borderline nonstationarity). In view of this result, it appears thatthe process generating the natural logarithm of foreign currency futures rates may well be approximated by random walks.

Victor L. Bernard, Thomas J. Frecka, Commodity Contracts and Common Stocks as Hedges against Relative Consumer Price Risk, The Journal of Financial and Quantitative Analysis, Vol. 22, No. 2 (Jun., 1987), pp. 169-188