Knowledge that Transforms

Weeden & Co.'s business is that of making markets. We do it in many different types of securities and we take considerable inventory risk in the process. As market makers we learn to be direct in our dealings. “My market is 62 bid; offered at 62½.” “I can offer 5,000 at 62½ net.” The pace and the pressures of the marketplace tend to make us impatient with those who speak in vague terms, who mask their intentions, or who do not know the facts.

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George G. Kaufman, The Strange Journey of Monetary Indicators, The Journal of Financial and Quantitative Analysis, Vol. 7, No. 2, Supplement: Outlook for the Securities Industry (Mar., 1972), pp. 1625-1639

Regression analysis is by far the most popular of all the statistical techniques employed in financial research. Almost without exception, the models employed have been additive in both the parameters and the variables (regressors).

If a firm is considering replacing part of its productive facility because of obsolescence rather than wear-and-tear (e.g., purchasing a new model machine), it weighs the expected gains against the expected costs. A problem may arise when the rate of technological innovation for the type of machinery is extremely rapid. Such replacement may yield a gain if made today, but because innovations are so rapid, a year's delay in replacement may yield a greater net gain, and it would seem wiser to wait the year. But each year the same reasoning seems to hold; the more rapidly innovations seem likely to occur, the more likely a firm is to delay. If technology is advancing quickly enough, a firm may never consider any time a good time for replacement.

Elliott's basic proposition is praiseworthy. Nevertheless, I have a number of serious reservations about the implications of his model and the reliability of its predictions. Some of my reservations relate to the theoretical foundation of the model itself, while others are concerned with his methodology and estimation techniques.

Aggregation of monies must be determined in accord with the theory using the aggregate. This theory must specify aggregation (1) eligibility rules and (2) weights. Four current methods are evaluated on this basis: Fisher's aggregation bases eligibility on significant quantities Vi of monies Mi and attaches quantity weights Vi/Vn (Vn being numeraire). Pesek-Saving aggregation merely substitutes social marginal value weights Vipi/Vnpn. Friedman-Schwartz aggregation has eligibility depend on good subsequent statistical performance and uses weights given by private marginal values (gross of subsidies). Chetty's aggregation has all assets eligible and weighted by cross-elasticities of demand.

Studies [1, 3, 4, 5] pertaining to the relationship between a firm's cost of capital and the debt component of its capital structure have been implicitly assuming the equivalent-risk class hypothesis to be true. According to the hypothesis, firms belonging to the same industry group do not exhibit significant differences in regard to business risk and can, therefore, be treated as belonging to an equivalent risk class. The validity of this hypothesis, as borne out by the research of Wippern [8] and, later, of Gonedes [2], has become questionable. The purpose of the present paper is to replicate the test carried out by Gonedes with a set of sampled data from Indian industries. A brief review of the two existing studies is given below.

William L. Sartoris, The Effect of Regulation, Population Characteristics, and Competition on the Market for Personal Cash Loans, The Journal of Financial and Quantitative Analysis, Vol. 7, No. 4 (Sep., 1972), pp. 1931-1956

Robert A. Haugen, James L. Pappas, Equilibrium in the Pricing of Capital Assets, Risk-Bearing Debt Instruments, and the Question of Optimal Capital Structure: A Reply, The Journal of Financial and Quantitative Analysis, Vol. 7, No. 4 (Sep., 1972), pp. 2005-2008