Knowledge that Transforms

As an operational objective for firm management, the market value maximization criterion derives its theoretical validity from the Fisherian separation principle which states that production decisions for an economy can be made without regard to consumer-investors' preferences for consumption, given perfectly competitive markets. In other words, if the firm's activities do not affect the prices of consumptive goods, then maximizing the wealth of its shareholders will lead to a maximization of each shareholder's utility. Not only does this optimality criterion avoid the ambiguities and vagaries of constructing an aggregate shareholder preference function, but when implemented as a firm decision rule, should result in the same production plan that each investor would select himself, and thereby should represent a Pareto optimal allocation of resources: (Hirshleifer [5, Chapters 1, 9]; Fama and Miller [3, Chapters 2, 7]; and more recently, Ekern and Wilson [2], Merton-Subrahmanyam [7], LeRoy [6]).

Professors Kau and Keenen (K & K) explore in this paper the microeconomic foundations of the demand and supply of housing. In order to investigate these foundations, K & K adopt the standard neoclassical framework: the demand for housing arises from solution of a multiperiod consumption problem; and, the supply of new housing is derived from a one–period profit maximization problem. Within this general framework, K & K argue that owner–occupied housing is distinguished from other consumption goods by its durability. As a consequence of this durability, the stock of housing held enters into each period's budget constraint. The utility, on the other hand, from housing enters only as a flow of services in each time period. Because of the stock/flow nature of housing, the comparative statics of the model become interesting. K & K investigate the comparative statics of the model with special attention focused on the impact of changes in the real rate of interest. K & K show, by use of fairly elegant duality theory, that if consumers of owner–occupied housing are net debtors, then an increase in the real rate of interest leads to a fall in the immediate demand for housing. This result is as it should be, since an increase in the real rate of interest reduces the wealth of net borrowers for any given level of future income and, consequently, demand for normal goods falls. K & K argue that a similar net debtor condition must hold to produce the same result in the rental market. I am sure this is a stronger condition than is necessary since an increase in the real rate of interest lowers the price of future consumption and to the extent that current consumptions of rental housing are a substitute for future consumption, it would be expected that current demand for rental housing would fall.

In the late 1930s, Macaulay [7] and Hicks [6] independently introduced the concept of duration as a measure of the length of a stream of cash flows and a measure of the elasticity of the present value of the stream with respect to a change in the rate of discount, respectively. Approximately 15 years later, Reddington [8] and Heynes and Kirton [5] used the concept to develop interest rate immunization rules for the portfolio management of insurance companies. More recently, Fisher and Weil [1] have developed duration based rules to help investors find investments that will insure them of having some fixed amount of money available at a specific future point in time. In [2], Grove uses duration to link the investor's decision to speculate or immunize with his subjective forecast of future interest rate movements. Finally, Haugen and Wichern [3, 4] show the relationship between duration and the characteristics of bonds and stocks. Also, in analyzing the effect of financial leverage on interest rate risk, they demonstrate how the financial manager can manipulate the capital structure of his firm, so as to render the present value of the common stock insensitive to changes in the rate of interest.

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Lemma W. Senbet, Discussion: Signaling, Information Content, and the Reluctance to Cut Dividends, The Journal of Financial and Quantitative Analysis, Vol. 15, No. 4, Proceedings of 15th Annual Conference of the Western Finance Association, June 19-21, 1980, San Diego, California (Nov., 1980), pp. 871-873

Richard M. Levich, Discussion: The Denomination of Foreign Trade Contracts Once Again, The Journal of Financial and Quantitative Analysis, Vol. 15, No. 4, Proceedings of 15th Annual Conference of the Western Finance Association, June 19-21, 1980, San Diego, California (Nov., 1980), pp. 945-947

There are two well-known distinct aspects to the behavior of a risk-averse individual towards a risky proposition: the position he takes, long or short, with regard to the gamble, and the scale of the position taken–the amount by which he goes long or short. On one hand, the first aspect depends only on the individual's assessment of the expected return from the gamble relative to a safe return. The second aspect, on the other hand, will be influenced by the individual's degree of risk aversion and the level of risk of the gamble.

The question of stock market efficiency has received considerable play in the financial press in recent years and understandably so. Not only is this a topic of interest to national policymakers charged with monitoring and promoting market efficiency, but answers to this question have rather important implications for the management of market participants' portfolios. Our interest in this subject focuses on a subsegment of the larger question of market efficiency, in particular on so-called technical theories of stock market behavior.

The well known Sharpe-Lintner-Mossin capital asset pricing model (CAPM) assumes the existence of stability in the price level so that the market price of risk (MPR) measured in nominal terms is the same for all risky assets in an equilibrium market. Friend, Landskroner and Losq [5, hereafter F-L-L] have recently shown that CAPM measured in nominal terms understates the MPR if an uncertain inflation is expected and if a covariance between the rate of return on the market and the rate of inflation is positive (p. 1287).